Graham Doddsville Winter

Frank Martin

—

Winning by

Not Losing

Winter 2013 Issue XVII

Editors

Jay Hedstrom, CFA

MBA 2013

Jake Lubel MBA 2013

Sachee Trivedi

MBA 2013

Richard Hunt MBA 2014

Stephen Lieu

MBA 2014

Inside this issue:

Graham & Dodd

Breakfast P. 3

JANA Partners P. 4

Daniel Krueger P. 14

Frank Martin P. 28

Russell Glass P. 42

Jon Friedland P. 50

Visit us at:

www.grahamanddodd.com

www.csima.org

Graham & Doddsville An investment newsletter from the students of Columbia Business School

JANA Partners —

Collaboratively

Unlocking Value

Frank Martin

Barry Rosenstein Scott Ostfeld

Founded in 2001, JANA Part-

ners is a value-oriented in-

vestment advisor specializing

in event-driven investing.

G&D sat down with two of

the firm’s partners, Barry

Rosenstein and Scott Ostfeld

’02. Barry Rosenstein is the

founder and Managing Part-

ner of JANA Partners. Prior

(Continued on page 4)

Daniel Krueger ’02 is a Man-

aging Director and Partner

at Owl Creek Asset Manage-

ment, a hedge fund in New


Frank Martin is the founder and owner of Martin Capital

Management, an investment partnership based out of Elkhart,

Indiana. He is the author of two books on investing,

Speculative Contagion (2005) and A Decade of Delusions (2011).


Russell Glass

Russell Glass

—

Arbitrageur of

Value

Russell Glass is founder and managing partner of RDG Capital

Management, a New York-based investment management

firm that specializes in activist investing. Prior to RDG

Capital, Mr. Glass served as President of Icahn Associates, the

investment firm of Carl Icahn. A passionate sports fan, Mr.


Jon Friedland —

Searching for

International

Battleships Jon Friedland

Jon Friedland ’97 is the Director of International Research at

Amici Capital (formerly named Porter Orlin). He is

responsible for sourcing and analyzing the firm’s international

long and short ideas. Prior to joining Amici in 2001, he

worked at Zweig-Dimenna Associates, a New York-based


Daniel Krueger

Daniel Krueger

— “Uncertainty

is our friend”

http://www.grahamanddodd.com

http://www.csima.org

Welcome to Graham & Doddsville

very attractive risk-return sce-

narios, as well as how he en-

courages his team, in their

early work on a company, to

zero in on the key questions

that need to be answered.

Frank Martin from Martin

Capital Management de-

scribed how he picks compa-

nies on a bottom-up basis, yet

spends much of his time thor-

oughly studying the macroeco-

nomic environment. He also

explained his reasoning for

having a conservatively posi-

tioned portfolio today. Mr.

Martin goes into detail about

the behavioral aspects of in-

vesting and what he does to

avoid traps to which many

investors fall prey.

Activist Russell Glass from

RDG Capital made us very

envious when he shared his

unique business school and

early career experiences. Mr.

Glass thoroughly shared how

his firm has been able to profit

handsomely by actively advo-

cating for the sale of underval-

ued companies. He also illumi-

nated for us how the large

amounts of cash in private

equity and corporate hands

could lead to a robust mergers

and acquisitions environment in

the coming years.

Jon Friedland ’97 from

Amici Capital shared with us

the factors that make a com-

pany a ‘battleship’ company.

He then conveyed the attrac-

tiveness of searching for these

companies in emerging mar-

kets.

This issue also contains pic-

tures from the 22nd Annual

Graham & Dodd Breakfast,

which took place on October 5

at the Pierre Hotel in New

York. Investing luminaries

Tom Russo, Bill Ackman, Mario

Gabelli, William von Mueffling,

and others were on hand to

mingle and listen to keynote

speaker Meryl Witmer from

Eagle Capital Partners.

We thank our featured inves-

tors for sharing their time and

insights with our readers.

Please feel free to contact us if

you have comments or ideas

about the newsletter as we

continue to refine this publica-

tion for future editions. We

hope you enjoy reading this

issue of Graham & Doddsville

and find the interviews as infor-

mative and thought-provoking

in written form as we found

them to be in person.

We are proud to bring you the

latest installment of Graham &

Doddsville. This is the 17th edi-

tion of Columbia Business

School’s student-led investment

newsletter, co-sponsored by the

Heilbrunn Center for Graham &

Dodd Investing and the Colum-

bia Student Investment Manage-

ment Association.

We were very fortunate to sit

down with six well-respected

and successful investors that

span the value investing spec-

trum – they prove the old ad-

age, ‘there is more than one way

to skin a cat.’

Barry Rosenstein and Scott

Ostfeld ’02 from JANA Part-

ners explained their process for

constructively engaging manage-

ment in activist situations. They

also talked about how their

entrepreneurial backgrounds

have helped shape their careers

and the way they look at compa-

nies.

Distressed expert Dan

Krueger ’02 from Owl Creek

Asset Management shared

the intricacies of distressed debt

investing that make it his favor-

ite hunting ground for ideas. He

also explained how the econom-

ics of averaging down create

Pictured: Professor Bruce

Greenwald. The Heilbrunn

Center sponsors the Ap-

plied Value Investing pro-

gram, a rigorous academic

curriculum for particularly

committed students that is

taught by some of the in-

dustry’s best practitioners.

Pictured: Heilbrunn Center

Director Louisa Serene

Schneider. Louisa skillfully

leads the Heilbrunn Center,

cultivating strong relation-

ships with some of the

world’s most experienced

value investors and creating

numerous learning oppor-

tunities for students inter-

ested in value investing.

The classes sponsored by

the Heilbrunn Center are

among the most heavily

demanded and highly rated

classes at Columbia Busi-

ness School.

The Columbia Student Investment Management Association (CSIMA) will be

awarding its inaugural scholarship this spring with the proceeds from today’s conference. Through this program, we will award a $10,000 scholarship to

an incoming Columbia Business School student that exhibits an outstanding aptitude and commitment to investment management. All incoming MBA

students in the Class of 2015 are eligible to apply and the recipient will be chosen by a panel of CSIMA students.

We are excited to initiate this scholarship and look forward to making this

an annual tradition.

CSIMA Scholarship

Volume I, Issue 2 Page 3 Issue XVII

22nd Annual Graham & Dodd Breakfast, Oct 5, 2012 at Pierre Hotel

Mario Gabelli with William von Mueffling

Dean Hubbard thanks Ms. Witmer

Prof. Greenwald makes a point Engaged audience

Tom Russo in deep conversation with Sid and Helaine Lerner

Bill Ackman

“Bring a sharp pencil and leave your emotions at home!” – Meryl Witmer

Keynote Speaker – Meryl Witmer

JANA Partners

out of business school. The

interviews didn't go that

well for me, and there

weren't big banking pro-

grams like there are today.

What did lead to a job was

cold-calling. The trick I

used to get jobs coming out

of business school was to

call people after 5:00 p.m.,

when their secretaries had

left, so that the person I

really wanted to speak to

would likely pick up the

phone themselves. In the

case of my first job oppor-

tunity, I cold-called a Whar-

ton alumnus at a boutique

firm called Warburg,

Becker, Paribas. Unfortu-

nately, the first week on the

job, the firm was sold to

Merrill Lynch and I was

again without a job. That

was the start of my career.

Fortunately, Merrill called

me about a week later and

told me I could interview

for a job with them and,

apparently, they needed

bodies so they hired me. I

worked in banking for about

two and a half years but I

frankly didn't like it that

much.

Back in the mid-80s, corpo-

rate raiders were beginning

to make themselves known,

and I would excitedly read

about their exploits at the

time. That was an interest-

ing world to me, so the

question was how to get

into that field? I once again tried the cold-call technique

(I don’t remember how I

found his number) to speak

to one of the main raiders

of the time – a guy named

Asher Edelman – and

wouldn't you know it, he

answered the phone. I

started talking as fast as I

could and he finally said,

"Well, come on in." This

led to me becoming Edel-

man’s co-head of takeovers,

a job for which I really was-

n’t qualified.

G&D: Can you tell us the

story of how you actually

got the job offer from Asher

Edelman?

BR: Asher was the corpo-

rate raider back then, and I

was a nobody associate at

Merrill Lynch; no one there

even knew who I was. He

started by telling me that

he'd been talking to the

heads of the M&A depart-

ments at various investment

banks about coming to

work for him to co-head his

takeover business. I didn’t

understand why he was tell-

ing me this as it had nothing

to do with me. After about

15 minutes, he turned to me

and said, "I think you and I

are going to do a deal here."

I had no idea what he

meant. Then he asked,

"What's it going to take to

get you to take this job?"

At the time, I was making a

salary of $40,000 and hoping

for a $30,000 bonus, but my

reviews were not strong so

I didn't have high hopes. I

had heard that the top mer-

chant acquisition bankers

made $1 million, which was

more money than I had ever heard of in my life. So I said

to him, “one million dol-

lars." He stared at me for

30 or 45 seconds, which is a

long time when you're com-

pletely full of crap. Then he


to founding JANA Part-

ners, Mr. Rosenstein was

the founder and Managing

Partner of Sagaponack

Partners, a private equity

fund. Mr. Rosenstein re-

ceived his MBA from

Wharton and his B.S. from

Lehigh University. Scott

Ostfeld is a partner of

JANA Partners and is re-

sponsible for special situa-

tions investments, includ-

ing active shareholder en-

gagement. Prior to joining

JANA Partners, Mr. Ostfeld

was with GSC Partners in

its distressed debt private

equity group. Mr. Ostfeld

received his MBA from

Columbia Business School,

his J.D. from Columbia Law

School, and a B.A. from

Columbia University.

G&D: Can you tell us

about your background and

how you became interested

in investing?

Barry Rosenstein (BR): I

wasn't one of these people

who invested when I was

nine years old. I was good

at math and I was interested

in business. Frankly, I didn't

really know much about

Wall Street at all but as I

read more about the busi-

ness world when I was in

college, it became clear to

me that I should go back to

business school. I did so at Wharton. There seems to

be a hot industry anytime

that you are in graduate

school. When I graduated

from Wharton in 1984, in-

vestment banking was the

hot field, so that's where I

focused my efforts.

I actually didn't have a lot of

luck getting a job coming

(Continued from page 1)

Barry Rosenstein

Scott Ostfeld


JANA Partners

jaw hit the floor.

G&D: Clearly you had a

lot to learn essentially start-

ing from scratch. What are

some of the things that

stand out in your mind that

you learned during that pe-

riod working for Asher that

shaped the way you run the

firm today?

BR: I didn't really learn

anything technical from

Asher. I learned technical

balance sheet analysis and

business analysis more

through working on situa-

tions, talking to bankers,

and talking to some of the

other people who were

working at the firm. But

from Asher, I probably

learned more important

skills. These had more to

do with taking risks while

not blinking and remaining

fearless. I give him a lot of

credit. He wasn't the most

technically savvy guy, but he

had great instincts and he

never showed fear, even if

he felt it at times. That was

an important lesson.

G&D: Mr. Ostfeld, can you

walk our readers through

your unique background?

How has this background

impacted your investment

style?

Scott Ostfeld (SO): I was

an Art History major when I

was in undergraduate school

at Columbia, so that didn’t

necessarily portend a career

in finance. I started two

businesses in college. I

started a menu business

where the restaurants

around Columbia paid me

to put their menus into a

menu book that I distrib-

uted to students for free.

This was just before the

Internet had taken off,

which certainly would have

put me out of business. I

also started an event plan-

ning business. One of the

problems back then as a

Columbia undergraduate

student was that there was

no central place to congre-


said, "Alright, done. You

just have to start tomor-

row," to which I responded,

"I'll start right now. I'll sleep

here tonight if you want."

That's how I became co-

head of takeovers for Asher

Edelman. I wasn’t prepared

for the position when I

started, so I had to figure

out the responsibilities of

the role as I went along.

This made for a uniquely

amazing experience.

G&D: How old were you

then?

BR: I was 27.

G&D: That was quite a

career advancement at that

age!

BR: I'll add a funny post-

script to it, as well. The

very first deal I was working

on, we were trying to take

over a supermarket chain called Lucky Stores and sure

enough, Edelman had ap-

proached Merrill Lynch for

the takeover financing.

About a week into my job

as co-head of takeovers,

Merrill’s senior M&A team

came in to our office to talk

to us about the financing. I

noticed the Merrill people

looking at me as they were

probably thinking, “What's

he doing here? I didn’t know

he was assigned to the

deal.” I was so insignificant

at Merrill Lynch that nobody

even knew I had left. So

Asher gave his 30-second

introduction and then said,

"My co-head of takeovers,

Barry here, is going to take

you through the financing

we're looking for." Every


“But from Asher

[Edelman], I

probably learned

more important

skills. These had

more to do with

taking risks while

not blinking and

remaining fearless.

I give him a lot of

credit… he had

great instincts and

he never showed

fear, even if he felt

it at times. That

was an important

lesson.”

JANA Partners

During my time in business

school and law school, I

spent a summer at Wachtell

Lipton, which today happens

to be on the other side of

our firm in activist situa-

tions. That was an interest-

ing experience that helped

frame the debate on share-

holder versus board and

management power. After

graduation, I went into in-

vestment banking, where I

focused on helping compa-

nies unlock value. From

there, I moved into dis-

tressed private equity. That

was basically investing in the

context of a legal process to

gain control of a company

and improve value as an

equity owner, which was

again leveraging many of my

skills and experiences. I then

moved to activism when I

joined JANA Partners about

seven years ago, which puts

all of my experiences to

work evaluating companies

with an owner orientation

to figure out how to unlock

value.

G&D: Mr. Rosenstein, you

were involved in many en-

trepreneurial situations be-

fore you founded JANA –

will you talk about a few of

them?

BR: My career is not very

conventional. I didn't grow

up in the hedge fund busi-

ness and work for a bunch

of people and then decide to start my own firm. I was

kind of a serial entrepre-

neur. Some things worked

and some things didn't

work. When I left Asher, I

did two things. First, I went

off on my own and I made a

tender offer to try and buy

a public company called

Justin Industries, which was

the largest manufacturer of

cowboy boots and bricks in

the country. I never ac-

quired control of the com-

pany, however. [Editor’s

Note: This Company was later

acquired by Berkshire Hatha-

way in 2000.] It was an in-

teresting experience being

the person on the firing line,

as opposed to somebody's

right-hand man. It was also

interesting trying to go after

the oldest company in the

state of Texas.

I also became involved in

the cellular industry. I was

invited by a group of gentle-

men to form a partnership

that submitted applications

for all of the remaining rural

cellular licenses in the U.S.

that had not yet been

awarded. The FCC didn't

hold auctions at that time –

they just held a lottery – so

all one had to do was apply.

We invested a relatively

small amount of capital to

meet the legal fees associ-

ated with applying and we

then applied to every loca-

tion in the country. We

figured we had a one in

three chance of winning one

of them. It was like playing

the lottery but with much

better odds. In fact, we

won Mississippi and the

Poconos and, after building

the necessary systems, sold them for a terrific return.

I then moved to San Fran-

cisco at the end of 1991.

Remember that this was

back when New York was


gate at night – you may have

seen somebody on campus,

but you never saw them at

night. So I started initiating

events at different venues

for Columbia students,

where I was paid to bring

students. It grew to the

point where I was organiz-

ing events for Tahari and

Lacoste in New York and

even Miami. Toward the

end of my time as an under-

graduate, I applied to the

law school thinking I wanted

to be a lawyer, though not

necessarily understanding

what that meant. I also had

an entrepreneurial orienta-

tion, so on a whim I said,

“Maybe I should go to busi-

ness school as well.” I was

lucky because the business

school typically doesn’t ad-

mit candidates with no real

work experience.

The foundation of entrepre-

neurial experience, law school, and business school

has helped me as an activist

investor. Entrepreneurial

experience gave me an

‘owner orientation’ that is

very helpful in thinking

about how to create value

at companies. Business

school and law school gave

me many of the foundational

tools to be a competent

analyst. Believe it or not, I

had never even used Excel

before I attended business

school. Courses like Ad-

vanced Corporate Finance,

Corporate Restructuring

and Corporate Tax gave me

a great foundation for ana-

lyzing companies and think-

ing about ways to unlock

value.



JANA Partners

and use them again and

other people buy them for

the parts.

I became curious about auto

salvage after someone had

mentioned that it could be

attractive. So I started call-

ing one participant in the

industry after another, each

more unsavory than the last.

I finally met a guy named

Willis Johnson who had a

little company called Co-

part. At the time, Copart

had one location in Califor-

nia, generated $8 million in

revenue, and offered neither

audited financials nor GAAP

accounting. Copart was

basically a dirt lot with a

barbwire fence and dogs

running around. The head-

quarters building was a tem-

porary corrugated metal

building, and Johnson frac-

tured the English language

regularly. The only thing

that I could think of, as I

was trudging around in the

mud with the CEO, was

that I can't believe my ca-

reer has fallen this far, this

rapidly. Nevertheless, I

probably spent four hours

with Johnson. I remember

calling my wife on the phone

on the way back to San

Francisco and saying, "You

know, I think I just met the

smartest guy I have ever

met in business."

Willis Johnson was a self-

taught, self-made business-man. He had a vision for

creating a national company

and signing national con-

tracts. He also believed he

had a way of sharing the

proceeds with the insurance

companies so that there

was an incentive to get bet-

ter pricing. He had all kinds

of ideas that no one in his

industry had done to date. I

returned to my office in the

city and tried to scrape to-

gether the $7 million to

back him. I remember eve-

rybody telling me that I was

crazy being in this industry

and backing this person.

But I just saw something in

him. I was able to back him

and he turned out to be one

in a million. He bought a

number of companies, inte-

grated them very well, and

started to build a real com-

pany. Copart went public a

little over a year after my

investment. Today, it's a $4

billion market cap company

and it has hundreds of loca-

tions all around the world.

Their business has shifted to

the internet now, of course,

and today it's the biggest

online seller of automobiles

in the world.

G&D: What inspired you

to found JANA Partners and

to include a distinct activist

investing approach within

part of your business?

BR: So I made some

money on my various ven-

tures and that provided a

springboard for me to start

my own private equity firm

in 1997. I ran that for about

three years and produced

very average results for my

investors. It was a very difficult time for the private

equity market and I was just

happy that the investors

were returned their princi-

pal plus a small return. But I

really didn't like the busi-


going through extremely

difficult times – the home-

less problem was out of

control, Wall Street was

completely dead, and there

was nothing to do. In the

meantime, I met some peo-

ple in San Francisco who

asked me if I wanted to join

them to start a new invest-

ment and merchant banking

business. Not having any-

thing else to do, I decided

to give it a try for a year or

two and then return to

New York. I ultimately

stayed in San Francisco for

16 years! After about five

years of helping build that

successful little boutique

business, I left to start my

own firm.

G&D: Towards the end of

your time in San Francisco,

you made an investment in

Copart, the salvage vehicle

auction company. Could

you tell us about this busi-ness and your thesis at the

time?

BR: That’s right. Near the

end of my time on the west

coast, I did a deal which was

something of a life changer

for me in certain ways. Yet

again, I cold-called someone

– this time it was a partici-

pant in the auto salvage in-

dustry. Auto salvage is a

fragmented industry that

runs an auction on behalf of

insurance companies for

permanently damaged vehi-

cles. This is the company

that the insurance company

calls and says, "Go pick up

the car for us, turn it into a

salvage vehicle, run an auc-

tion, and sell it." Some peo-

ple buy the cars to fix them


Pictured: Mario Gabelli at

Omaha Dinner in May 2012.

JANA Partners

through 2008 and a big

downturn, with assets under

management falling a lot. I

restructured the whole firm

over the last couple of years

and we are back flying again.

Other than probably 2008

and a year or two after that,

it's actually been a lot of fun.

G&D: Does your activist

approach stem from the fact

that you have a sense of

what good businesses are

and how a business should

be managed to get to the

private market value? Is

that how you convince the

management to unlock the

value?

BR: Right. Nobody was

really doing that when we

started. There were a lot of

companies that were value

traps. They either needed

to restructure, sell off

money-losing businesses,

spin off an unrelated busi-

ness, or they just didn't be-

long independent and

needed to be sold. My ini-

tial impetus was to try and

force that kind of change.

G&D: Many value inves-

tors talk about having a long

-term approach, but at

JANA you have a medium-

term time frame. Why is

this the right time frame?

SO: I wouldn’t even call it

medium-term; I’d call it

‘right-term’. I think we’re

‘right-term’ because we try

to consider all available in-

formation and construct the

optimal plan for the com-

pany under the circum-

stances that are known or

knowable and predictable

over a reasonable period of

time to best position the company for success. I

think that’s the right time

frame, frankly, for a board

to be evaluating the oppor-

tunity set for the company.

So I think our horizon maps


ness. I felt like I couldn't be

entrepreneurial – if we won

a deal, it was because we

had offered to pay more

than everybody else. It was

right around 2000 when I

decided to not raise another

fund.

I instead saw an opportunity

in the public markets to

close what I saw as a gap

between the price at which

public companies were trad-

ing and what I felt their ulti-

mate private market values

were worth. So not know-

ing anything about how a

hedge fund works, I set up a

hedge fund.

I remember when I was

trying to raise money, trav-

eling to various institutions

and talking about being an

activist. People would say,

“That's not a strategy; you'll

never raise money; nobody

does that; forget it.” Things have really changed. My

very first investor was Lee

Cooperman [Editor’s Note:

Cooperman was featured in

Issue 13 of Graham &

Doddsville], who had been a

close friend for many, many

years and someone I viewed

as a mentor. He largely

understood the idea and

believed in what I was trying

to do. He backed me when

nobody else really would.

I started with $17 million

and no expectations beyond

that. Before I knew it, the

business grew and by 2007,

we had over $8 billion un-

der management. We gen-

erated a pretty strong track

record over this period of

time, as well. Then I lived


“I think we’re ‘right-

term’ because we

try to consider all

available

information and

construct the

optimal plan for the

company under the

circumstances that

are known or

knowable and

predictable over a

reasonable period

of time to best

position the

company for

success. I think

that’s the right time

frame, frankly, for a

board to be

evaluating the

opportunity set for

the company.”

Pictured: Louisa Schneider

and Glenn Hubbard at Gra-

ham & Dodd Breakfast in

October 2012.


JANA Partners

the last 10 years, but it's

never come down to a

proxy vote and you’ve

never been very vocal about

your position. How do you

engage management? What

makes the strategy possible?

BR: Well for the first part

of that, I would say you have

to be prepared to go all the

way because if you're not,

you'll be pushed as far as

you're willing to go and then

you have nothing. Nobody

ever questions whether

we're prepared to go all the

way. We are very careful

about how we prosecute

activism. We've never had

one actually go to a final

vote because management

comes to the realization

that there's no point going

to a final vote because

they're going to lose.

The reasons are twofold:

one is our approach and the

other is our structure. In

our approach, we're ex-

tremely disciplined. I don't

want to be only an activist

because then you force

things and the quality of

your ideas is diluted. We

don't ever have to be an

activist here. We can just

invest in event-driven situa-

tions. For something to be

an activist play, all of the

criteria have to be present

for us. We came up with

this rubric we call V-cubed,

which is Value, Votes, and

Variety of ways to win.

Basically, we have to be

comfortable buying in at a

valuation that provides us

with a margin of safety, irre-

spective of any activism we

will attempt to initiate and

that may be unsuccessful.

We have to be comfortable

that if it really came down

to a vote that we would

have shareholder support. And variety of ways to win

– you want to make sure

that there's more than one

lever you can pull in case

circumstances change. In

my experience, if you have


appropriately with the

board’s horizon.

G&D: How much overlap

is there between JANA’s

passive efforts (that is, non-

activist ideas in this context)

versus its activist efforts?

SO: We are one team, one

portfolio, all on one floor,

all interacting on a regular

basis. So there is a constant

flow of ideas from passive

to active, and frankly, many

of us can’t separate our

brain and say, “This one’s

clearly active, this one’s

passive.” Frequently posi-

tions fall in the middle. But

my primary focus is on the

activist side, and that’s what

I’m paying attention to 90%

of the time.

G&D: Does your activist

style impact your portfolio

construction – meaning,

does the fact that you are

often the catalyst enable you to be more concen-

trated than you would oth-

erwise feel comfortable

being?

SO: Yes. Our highest con-

viction ideas are the ideas

where we have the most

impact on the outcome.

Those are our activist ideas

which tend to be our largest

and highest returning posi-

tions in the portfolio.

You’re also, frankly, doing a

lot of work on these posi-

tions, so you want to bene-

fit from that work by mak-

ing it a large position. So

our portfolio can be a bit

more concentrated.

G&D: You've been an ac-

tivist in many companies in


“Basically, we have to

be comfortable buying

in at a valuation that

provides us with a

margin of safety,

irrespective of any

activism we will

attempt to initiate and

that may be

unsuccessful. We have

to be comfortable that

if it really came down

to a vote that we would

have shareholder

support. And variety of

ways to win – you want

to make sure that

there's more than one

lever you can pull in

case circumstances

change. In my

experience, if you have

all three of those

checked off, you're

guaranteed victory.”

JANA Partners

are.

SO: When we become

involved in situations, we

typically are working with

industry operators who are

helping us carefully analyze

the situation and are on

standby to become board

members if necessary.

Given our successful track

record and collaborative

reputation we are able to

attract very accomplished,

experienced, and successful

value creators who get a

very good reception when

we do bring them to com-

panies or run them for

slates. For example, when

we were involved in CNET

in 2008, we ran a slate of

directors to help turn the

company around. We had

very qualified people like

John Miller, who had run

AOL, and Julius Gena-

chowski, who only months

after being on our slate was

nominated by President

Obama to be chairman of

the FCC. As with CNET,

when we do run a slate, it’s

designed and tailored to

address the very specific

need at the company.

G&D: How do you go

about finding your activist

targets? Do you screen for

companies through valua-

tion screens or do you gen-

erally find your ideas

through other means?

SO: A friend who works at

another activist firm aptly

described it: it’s a bit like

panning for gold. You need

a lot of throughput to find

that gold nugget. I can’t say

we ever know where our

next idea is going to come

from, but looking for activist

ideas is very similar to how

you would look for tradi-

tional investment opportuni-ties in public equities.

There’s screening, reading

research reports, talking to

industry operators, talking

to companies about their

competitors, and bench-


all three of those checked

off, you're guaranteed vic-

tory. If you're missing one

of them, there's a good

chance you're going to lose.

We're extremely judicious.

In terms of our approach, I

have no ego with respect to

these activist pursuits. I

don't need to claim victory

or get credit. I try to work

behind the scenes. I tell

every one of these CEOs

that they can be the hero,

and we'll be their biggest

advocate, if they do what

we want them to do. In-

stead of going on TV and

forcing people or embar-

rassing people, I find it much

more effective when I give

them a chance and I treat

them with respect. We can

go hard at somebody if we

have to, but in my experi-

ence you convince people

to go along with you a lot

more successfully if you treat them the right way.

G&D: How is JANA Part-

ners structured to conduct

activist investing?

BR: We run our activism

activities like a machine. It's

what these guys do every

day, all day long. We also

bring in industry partners in

all of these situations; so

we're not just financial guys.

We bring in industry opera-

tors who have greater ex-

pertise and track records

than existing management

teams, so it's very hard for

the management teams to

argue against us when

they're arguing against peo-

ple who are better thought

of in the industry than they


“In terms of our

approach, I have no

ego with respect to

these activist

pursuits. I don't

need to claim

victory or get credit.

I try to work behind

the scenes. I tell

every one of these

CEOs that they can

be the hero, and

we'll be their

biggest advocate, if

they do what we

want them to do.”


JANA Partners

sue us or put a poison pill in

place. We don't get any of

that anymore, because the

companies have come to

realize that all they're doing

is alienating their own

shareholder base and it's

counterproductive. We

hire the same bankers and

lawyers all the time and we

know what they tell man-

agement teams, at least in

our case. They tell them,

“You can't ignore JANA.

They do their homework,

they come up with good

ideas, they're really tough,

they're not going to go

away, and you're better off

just trying to work things

out with them.” I think

those two broad dynamics

continue to create a great

environment for what we

do.

G&D: Has the recent in-

crease in funds with activist

strategies made it any

tougher for you to find your

ideas?

SO: There really aren’t

that many activists, and

there certainly aren’t that

many activists with a 12-

year track record of col-

laboratively unlocking value

the way that we have.

There are also not that

many activists that focus on

the market cap size that we

have participated in ($10-

$20 billion), particularly in

the past two years. It is actually much less competi-

tive today than it was prior

to the financial crisis when

everybody was an activist

investor. Yet the opportu-

nity set today is very attrac-

tive for activism.

G&D: What, in your opin-

ion, is a driving motivation

behind the subset of corpo-

rate America management

teams that have a penchant

for limiting or destroying

value for shareholders? Is it

related to self-preservation?

Empire building? Disen-

gaged boards?

SO: It’s very difficult to

answer because it runs the

spectrum. You sometimes

have companies with good

operators who think they’re

doing things that make

sense for shareholders, but

they may not be as experi-

enced navigating the capital

markets or as thoughtful

about ways to increase the

value of a stock. You also

have situations where CEOs

or boards are not prioritiz-

ing the right things. Some

may be interested in grow-

ing at the expense of

unlocking value. Other

times you get people in

situations that are not com-

petent enough to execute

the appropriate strategy to

maximize value.

BR: A big part of the prob-

lem is that the incentives

are all wrong. If these were

family businesses and they

owned all the stock, they

probably wouldn't be mak-

ing a lot of the decisions

that they're making. But

they own very little stock and most of the stock they

own has been given to them

or is in the form of options.

Their current compensation

is probably more valuable

and important to them. As


marking peers. Ideas can

come from other sharehold-

ers calling and from follow-

ing events that create op-

portunities such as an an-

nounced acquisition that

doesn’t make sense for

shareholders.

G&D: Mr. Rosenstein, you

said that last year was the

strongest environment for

activist investors that you

had seen in your career.

Do you think that's still the

case, and why is this?

BR: I do. I think there are

a couple of reasons for this.

In terms of opportunity set,

there are a lot of companies

that are undervalued. I find

stocks at very reasonable

prices. I think that you still

have a dynamic today that

exists where a lot of compa-

nies are worth a lot more

than where they’re trading

and where they would trade as private companies. I also

think balance sheets are

very healthy with lots of

cash. You have financing

rates that are very low.

You also have the dynamic

where companies and man-

agements are having diffi-

culty generating internal

growth and so they're as

open to value creating ideas

as they have ever been.

That's from an opportunity

set standpoint.

Then, if you think about the

environment for activism

and the market's perception

of activism, we don't face

the kind of fights that we

used to face. Ten years ago,

I'd show up in front of a

company and they would


“...we don't face the

kind of fights that

we used to face.

Ten years ago, I'd

show up in front of

a company and

they would sue us

or put a poison pill

in place. We don't

get any of that

anymore, because

the companies have

come to realize that

all they're doing is

alienating their own

shareholder base

and it's

counterproductive.”

JANA Partners

tions where assets are held

in inefficient structures, ei-

ther because there is a

more appropriate structure

to own it in like an MLP, or

you’re combining assets that

don’t make sense together.

I think it’s actually a coinci-

dence that we’ve had a few

in a row that have been

more spin-off focused. If

you went back and looked

at the activist situations

we’ve been involved in, and

you were to categorize

them, they are actually fairly

balanced among capital allo-

cation, capital return, block-

ing M&A deals, separations

or divestitures, buybacks,

sales of companies, and op-

erational turnarounds. The

common thread is that we

advocated steps that best

positioned the companies to

create value.

G&D: One oft-heard criti-

cism of activist investors is

that you are simply ‘pulling

value forward’ and harming

a company’s future pros-

pects. How would you re-

spond to this characteriza-

tion?

SO: As long as you’re do-

ing something that doesn’t

harm the value of the com-

pany, accelerating the bene-

fits to shareholders is ex-

actly what creating value is

all about. The best exam-

ple, of course, is buying back

stock. If you have a great long-term story and a value-

creating plan ahead of you,

why would you wait and buy

back stock after the market

fully reflects the value?

From a capital allocation

standpoint, you want to buy

back stock ahead of all that.

If an activist is pillaging a

business for some kind of

short-term gain, then that’s

problematic, but if they are

advocating steps that make

the stock more valuable,

then they are doing exactly

what the board and manage-

ment are supposed to do. If

an activist were harming a

company’s future prospects

every time they showed up

at a company, they would

not be successful winning

over shareholders who may

end up owning the stock

after the activist has sold

and moved on.

G&D: Is there any mistake

from your career that might

stand out or something that

you really learned from

them that sticks with you

today?

BR: I’ve made so many

mistakes I can't even think

about it. I'll give you one

thing that's not an investing

concept, but something that

I've come to realize that

might be helpful. Being po-

lite to people and treating

people with respect is good

business. It's not just a

good thing to do, it actually

inures to your benefit as

well. If you're a jerk to

somebody, they remember.

They may never get the

opportunity to pay you

back, but if they do, they

surely will. I've had more instances where I've inter-

acted with somebody I don't

even remember, perhaps 10

years prior and this person

shows up working for a

potential investor or is in-


a result, the incentive is to

run a bigger and bigger

company. The bigger the

company you run, the more

you can justify higher com-

pensation levels and it

makes you feel like a big

shot in town. The incen-

tives are all perverse. I

think ultimately when you

start to point out irrefutable

facts and you get share-

holder support they see

your point. I would say in

most cases, management is

trying to do the right thing,

but they're either blinded or

they are not necessarily

always looking to maximize

value. They're just going

about their business every

day and they're lost in the

forest a little bit. But you

also have some people who

are just not thinking about

things the right way and are

thinking about themselves

and not the shareholders.

They may protest and say that's not the case but it is.

It's not until someone like

us shows up and they feel

threatened that they actually

move. The proof is in the

returns we generate. In

virtually every situation, the

stocks have reacted ex-

tremely positively and not

just short-term bumps, but

companies have been

rerated. All of a sudden

companies go from being

value destroyers to value

creators.

G&D: Recently, JANA has

pushed for spin-offs in sev-

eral companies. Is that sim-

ply a coincidence, or do you

prefer to deal in spin-offs?

SO: We like to find situa-


“If you went back

and looked at the

activist situations

we’ve been involved

in, and you were to

categorize them, they

are actually fairly

balanced among

capital allocation,

capital return,

blocking M&A deals,

separations or

divestitures,

buybacks, sales of

companies, and

operational

turnarounds. The

common thread is

that we advocated

steps that best

positioned the

companies to create

value.”


JANA Partners

hire people unless they have

significant work experience.

I don't necessarily care that

they went to business

school, but they've got to

have significant work ex-

perience at an investment

bank and another hedge

fund or private equity fund,

and probably five plus years

of experience before we'll

bring them in as an analyst

here. Don't be afraid to make changes and jump. If I

thought about the down-

side, I wouldn't have done

half the things that I did.

And after the fact, as I sit

here, I think I must have

been out of my mind to do

some of these things. Just

take chances, go for it, and

don't look down.

SO: Investing is a lot

harder than Columbia Busi-

ness School. A hypothetical

'A' in the investing world,

the point at which you are

performing at the highest

level, only requires being

right more than half the

time. The truth is investing

can be very frustrating, diffi-

cult, unpredictable, and gru-

eling. So you should only

pursue the career if you

have the passion, if you’re

intellectually curious, and if

you’re committed to it, be-

cause at every turn, you can

be very quickly humbled.

That’s the nature of the

business.

G&D: Mr. Ostfeld, you

started with an entrepre-

neurial background and

ended up in a career in in-

vesting. What advice would

you give students who are

interested in both investing

and being involved in an

operating business?

SO: If you learn how to

invest and manage money

that’s portable to anything

you want to do.

G&D: Mr. Rosenstein and

Mr. Ostfeld, it’s been a

pleasure speaking with you.

volved with the company

and they say, "You were

really good to me. You

were really nice to me. I

didn't forget that." And

they've invested with us or

they've helped us get a com-

pany to do something. To

me there's no upside to

treating people badly.

SO: When I was working

in investment banking, I had

this naïve and mistaken view

that if you have a good idea

that a company should pur-

sue, it will automatically be

adopted and pursued.

Changing the status quo at a

company isn’t easy and

sometimes requires more

than just logic.

G&D: Do you have any

advice for the readers who

are keen to get into invest-

ing or activist investing?

BR: Go to places where you can learn. You can

learn from every experi-

ence, but just provide your-

self with the best opportuni-

ties to work with people

who you think are smart

and who you respect.

Maybe the world's changed

and you can go right into

the hedge fund space today,

but I still think there's

something to be said for

having more of a fundamen-

tal background, getting

training at an investment

bank or private equity firm,

and then moving into the

principal side and the public

markets. I think that's a

good way to access it. But

again, maybe hedge funds

are hiring directly out of

business school. We don't


“Being polite to

people and treating

people with respect

is good business.

It's not just a good

thing to do, it

actually inures to

your benefit as well.

If you're a jerk to

somebody, they

remember. … To

me there's no

upside to treating

people badly.”

Pictured: Bill Miller at CSIMA

Conference in February 2012.

Daniel Krueger

the debt was worth less

than face value and the eq-

uity was trading at option

value. I noticed that some

representatives of a dis-

tressed hedge fund that

owned the bank debt of one

of the companies were sit-

ting silently in the back of

the room at every meeting

and, even though they were

creditors, it was very clear that they were in charge,

not the stockholders. As a

junior analyst, a year out of

college, I found that dynamic

very interesting and very

intellectually stimulating.

That gave me a taste for

distressed. I really enjoyed

the complexity, the way that

different people had differ-

ent motivations, and that

the power shifted from eq-

uity holders to creditors in

such situations.

I eventually progressed to a

distressed analyst position

on the loan desk and then,

against the advice of my

colleagues, decided to go to

business school. I went to

Columbia Business School in

2000. Right around that

time, the default rate had

started to ramp up. Every-

body told me, “Krueger

you're being an idiot. Why

are you going back to busi-

ness school? You're picking

the exact wrong time to go.

You're going to miss the

entire cycle.” I figured they

may be right about that, but

I planned to be doing dis-

tressed for a really long

time, not just for the next

few years. I thought the

tools I could gain in business

school outweighed not be-

ing able to work on a few

distressed credits over the

next couple of years. Luck-

ily for me, they turned out

to be only partially right –

although the default rate

had moved materially higher

while I was in business

school, there was still a lot

to work on when I got out,

including Enron, Adelphia,

WorldCom, and others. I

started working at Owl Creek part-time during the

second semester of my sec-

ond year at Columbia Busi-

ness School and stayed on

full-time after graduating.

So I've been here for almost


York that manages over $3

billion. He is Co-Portfolio

Manager of Owl Creek’s

Flagship Funds and is the

firm’s Global Head of

Credit. Prior to Owl

Creek, Mr. Krueger

worked in distressed debt

at Chase Securities and

Angelo Gordon. Mr.

Krueger earned his A.B.

from Harvard College and

his MBA from Columbia

Business School.

G&D: What was your in-

troduction to investing?

DK: When I was graduat-

ing from college, I had no

idea what investment bank-

ing was, but I knew that all

of the smart kids were going

to New York to do it, so I

figured I would join them. I

came to New York and

worked for five years at

Chase in investment banking

and private equity, as well as

on the distressed loan desk.

As a junior analyst in the

healthcare group, I vividly

remember my boss and me

working on a proposed

M&A deal between two

companies that had stock

prices that were trading

pretty close to zero. What

I had learned in analyst

training, and what had been

reinforced through that

point in my career, was that the total enterprise value of

a company is the sum of its

debt, plus the number of

shares times the market

price of the shares, minus

cash. But that math didn't

really work in this situation.

It was very clear that the

math had broken down, and

it was because these were

distressed companies where


Daniel Krueger

“It was very clear

that the math had

broken down, and it

was because these

were distressed

companies where the

debt was worth less

than face value and

the equity was

trading at option

value...it was very

clear that [the

creditors] were in

charge, not the

stockholders.”


Daniel Krueger

ple of major distressed cy-

cles. I've certainly learned a

lot from Jeff since I joined

him and I've learned a lot

from being in this position.

I’m now a Co-PM of Owl

Creek’s Flagship and Credit

strategies and Global Head

of Credit.

G&D: Could you share

some of the unique aspects

of distressed credit investing

that you particularly appre-

ciate?

DK: I feel very fortunate to

work in distressed debt,

especially in schizophrenic

markets like these where

there is massive volatility all

around the world. This is

an event-driven investor’s

dream, and no style of value

investing is more event-

driven than distressed, in

my opinion. I always ap-

proach things with the same

mindset asking myself:

“What is it that I don't

know, and do I really know

any better than the next

guy?” What I love about

credit, and distressed in

particular, is that you have

built-in events that you can

analyze. For example, here

at Owl Creek, most of our

best investments are ones

that we never need to sell.

We’ll buy loans or bonds

and then get taken out for

cash at maturity, or there

will be a liquidation.

There’s an element of sepa-ration from macro events.

We may buy a bond at 80

(meaning that the market

price equals 80% of the face

amount) that matures in a

year, knowing that while the

market may move over the

next 12 months – Greece

may do this, the Japanese

Yen will do that, China may

have a hard landing or a soft

landing – the liquidity of the

issuer, which we spent ex-

tensive time analyzing, is

almost entirely independent

of those things. I know that

I don't need other investors

in the market to pat me on

the back and say, "Good

job. That’s a smart invest-

ment and now I want to

make it too." The treasurer

of that company will either

wire us the money at ma-

turity or not. If they do,

then we know exactly what

our return profile will be –

the 20 points from 80 to

100 plus the coupons.

That's a huge asset to have

in investing – these defined,

built-in events.

We take risk for a living, all

investors do, and we are

comfortable with that.

What I like about the dis-

tressed asset class, though,

is that the risks we are tak-

ing are concentrated around

the things we are analyzing,

leaving fewer unanalyzable

risks to worry about. Your

results should, over time,

more accurately reflect the

quality of the work that you

do and the soundness of the

investment thesis, as op-

posed to other big-picture

things that can make valua-

tions move up and down

every day.

G&D: Are you involved at

all in the equity side of

things?

DK: I will occasionally


11 years.

G&D: How did you make

the decision to join Owl

Creek, a start-up fund at the

time?

DK: During the summer

between my first and sec-

ond years of business

school, I worked at Angelo

Gordon, which was a leader

in distressed debt investing.

I really liked my experience

at Angelo Gordon. Those

guys have mostly moved to

different places now, but Jeff

Aronson and the other

members of the team are

some of the smartest guys

I've ever been around. They

weren't hiring full-time ana-

lysts at the time, so they did

me a big service by intro-

ducing me to other people

like Jeff Altman, who is the

Managing Partner of Owl

Creek. When Jeff gave me

an offer, it was really a no-brainer because I was join-

ing somebody who already

had a tremendous pedigree

and background (from his

time at Franklin Mutual

working with Michael Price),

who was a known money-

maker, and somebody from

whom I would learn a lot. I

was getting in at the ground

floor, so I looked at it and

thought, “This is great, if it

works it's going to really,

really work and I would

have been the first analyst

that he hires. If it doesn't

work – I'm twenty some-

thing years old and single.

I'll go find another job.”

Luckily for me, it did work

and it's been a great ride

over the past 11 years, dur-

ing which we've seen a cou-


“We take risk for a

living, all investors

do, and we are

comfortable with

that. What I like

about the distressed

asset class, though,

is that the risks we

are taking are

concentrated

around the things

we are analyzing,

leaving fewer

unanalyzable risks

to worry about.”

Daniel Krueger

for a security, which scenar-

ios are more or less likely

to occur, and how much

money you can make or

lose in the different scenar-

ios. Once you’ve estab-

lished a proper framework,

the answer jumps off the

page, and it’s a matter of

deciding if the opportunity is

attractive enough to go into

the portfolio or not.

G&D: Do your analysts

focus on specific sectors or

are they generalists?

DK: Most people here

start off as a generalist but

over time develop expertise

in certain industries. In

terms of division of labor, it

makes sense to have some-

body who's already looked

at five media companies

look at the next one, if they

can. On the other hand,

some of the most interest-

ing conversations we'll have

around here are the ones

where we get a fresh set of

eyes looking at an industry

or company, which I think is

what really separates good

investors from average

ones. We don't think that

we're the smartest people

that work at hedge funds. If

we’ve added a secret sauce

to our portfolio construc-

tion, it has come through

our group dynamic, con-

stantly reminding ourselves

that we can be shocked by

things that were previously unknown, and reminding

each other to remain intel-

lectually honest. If you use

intellectual honesty to as-

cribe probabilities to differ-

ent sets of events, over time

smart investors should do

well if they stick to their

discipline and don’t get car-

ried away with the sea of

noise that exists in the fi-

nancial media.

G&D: Could you talk a bit

about idea generation at

Owl Creek?

DK: Ideas are generated by

everyone, from Jeff Altman

at the top to the summer

analyst. We don't take a

whole lot of pride in idea

ownership here. We're

trying to make money with

the capital that we invest. If

an analyst comes up with an

idea, they'll bounce it

around with the PMs and

other analysts, getting differ-

ent people’s perspectives.

As an example, one of our

analysts was a bankruptcy

lawyer for a number of

years before going to the

buy-side and his niche at

Owl Creek is to evaluate

the legal component of our

ideas – mostly on the credit

side but occasionally on the

equity side as well. So you’ll

usually have multiple people

chiming in on an idea. Our

belief is that the more peo-

ple you have taking a look at

something, the higher the

probability that you either

eliminate what is only a me-

diocre idea or recognize

when you’ve got something

pretty special. To us, that’s

just simple math. I hear

some people at other places argue that if you open up

the discussion to too large

of a group, then you make it

too hard to get ideas into

the portfolio, because it’s

easy for one or two people


work on equities. I head up

the credit side of the port-

folio and my colleague, Jeff

Lee, heads up the equity

side and we both report to

Jeff Altman. But there have

been periods of time over

the past 11 years where

there has been less to do in

credit. Distressed is a cycli-

cal business and you need to

know when to really press

your bets and you need to

know when to walk away.

The trick is that in those

times when you are sup-

posed to be loading the

boat, it usually makes you

sick to your stomach to add

risk, so it’s easier said than

done. But in those periods

of time when we are doing

less in credit, I might work

on equities.

The analyst team here is

pretty fluid between credit

and equities. You don't

really notice a difference in terms of the conversations

around here, whether

you're talking about a credit

or a stock. It's all about:

“What is causing the mis-

pricing in the market price?

What advantage do we

think we have in terms of

our view? How high is our

conviction level? What is

our margin of safety for

being wrong?” The answers

to those questions help us

decide whether an idea will

go into the portfolio or not,

and, if it does, what size it

should be. The framework

for analyzing risk/reward is,

to us, identical no matter

what type of security you’re

looking at. Namely, you

need to understand the

range of possible outcomes


“If you use

intellectual honesty

to ascribe

probabilities to

different sets of

events, over time

smart investors

should do well if

they stick to their

discipline and don’t

get carried away

with the sea of

noise that exists in

the financial

media.”


Daniel Krueger

if the price moves against

us. If you think about it

mathematically, in a perfect

world, if you're looking at a

bond that's trading at 50

cents on the dollar and you

pass on it, if it moves to 49,

it should be slightly more

attractive now, assuming all

else is equal. And then at

48 it's even slightly more

attractive, etc., etc. Eventu-

ally it could get to a point

where you think it's attrac-

tive enough to go into your

portfolio, and let's say that's

at 43. Now, you couldn't

possibly want to make it a

giant position at 43, other-

wise you should have

bought some at 44 because

the risk/reward isn't that

dramatically different. So

we'll usually dip our toe in

to start and let the risk/

reward come to us.

Our best investments are

ones where we dip our toe

in at, to take the prior ex-

ample, 43 cents on the dol-

lar and a few days or weeks

or months later it's trading

at 31. In distressed, that

happens all the time. Bonds

can move up and down by

10 points on headlines like

litigation outcomes, a

busted financial covenant,

the sale of a business, or

something else significant,

but sometimes the price can

swing around on no news at

all. If the latter happens,

then you can load up the boat at the lower prices.

Lehman Brothers is a great

example of irrational price

moves – that bond started

trading in the 30s the week

that it filed, and then it was

in the 20s and people

thought “Why did I buy in

the 30s?” Then it was in the

low teens and they thought,

“Wait a minute, what am I

missing? I must not be get-

ting something.” Then the

CDS [credit default swap]

auction (which occurs a

month after a default)

priced the bonds around

nine. Granted, Lehman's a

very bizarre animal because

that was of course the big-

gest bankruptcy of all time.

A huge amount of debt all of

a sudden went from invest-

ment grade hands to looking

for a home in the distressed

market, which was not

nearly large enough to ab-

sorb that amount of paper.

But that’s the point: a good

investor needs to under-

stand that the value of a

security is built from the

bottom up, using good

analysis, and that markets

follow valuation. Not vice

versa.

G&D: Since it's more likely

that a judge or some other

third party will get involved

in the distressed space rela-

tive to non-distressed credit

or equity investing, how do

you get comfortable with

the risk/reward of your in-

vestment ideas given this

additional layer of uncer-

tainty?

DK: That's a great ques-

tion. You're teeing up an

answer that is very impor-tant to get across in order

to properly describe the

opportunities in distressed

investing. First of all, uncer-

tainty, to us as distressed

investors, is our friend, be-


to torpedo the sentiment.

But I think that’s exactly the

point. There are thousands

of securities out there that

we can invest in today that

are “pretty good,” but if

that’s the burden required

to get into your portfolio,

then what are you really

doing to differentiate your-

self? You know when you

have something special

when four, five, or ten

smart people can sit in a

room and agree that the

risk/reward is uniquely

good, and I’m fortunate at

Owl Creek to be sur-

rounded by such people.

G&D: When you’ve fully

analyzed something and

you’re comfortable that it’s

still attractive, do you

gradually build a position in

the name or do you estab-

lish the full position immedi-

ately?

DK: As you can imagine,

we pass on more than 90%

of the things that we look

at. If it does pass the initial

smell test, analysts will

come into my office if it’s on

the credit side or Jeff's office

if it's on the equity side, and

we'll bounce the idea

around a little bit. If it con-

tinues to look interesting,

we'll usually get the whole

investment team together

to talk about it. The last

component is to decide that

we’re ready to dip our toe

in. We very rarely will

make something a full posi-

tion right off the bat. Usu-

ally what we prefer to do is

make it a small- to medium-

sized position but leave

plenty of room to add to it


Pictured: Michael Karsch of

Karsch Capital Management

at CSIMA Conference in

February 2012.

“...a good investor

needs to

understand that the

value of a security

is built from the

bottom up, using

good analysis, and

that markets follow

valuation. Not vice

versa.”

Daniel Krueger

man entities, you knew that

the numerator in a recovery

calculation was going to be a

giant number.

At that point the analysis

turns to the denominator –

the other unsecured claims.

In that regard, some people

were talking about these

really scary things, swap

contracts, guarantee claims,

customer losses, etc., and it

sounded really bad. But

what you were supposed to

be doing is building your

waterfall model, under-

standing all of the different

variables, and coming up

with a realistic range of out-

comes from bad to good. If

you had done this, you

would have realized that

even in the worst possible

scenario, you still got an

answer where you're not

going to lose a lot of money

from nine cents on the dol-

lar because you were essen-

tially the most senior part of

the waterfall, and where

across most of the range of

outcomes you would be

making very good risk-

adjusted returns. To put

numbers around this, if your

base case showed a recov-

ery of 30 cents on the dol-

lar, your estimated claims,

the denominator, could be

twice as bad as in your base

case and you’d still get a

recovery of 15 cents on the

dollar and earn a double-

digit IRR over five years. That’s a pretty massive mar-

gin of safety. So high uncer-

tainty, low risk is a subcate-

gory within distressed that

we love.

Secondly, we don't think

that a judge's decision on

litigation is an unanalyzable

blue cell. We talk about

such things every day here

at Owl Creek. We also

hire outside counsel to

chime in on these issues,

which is money very well

spent when considering we

manage a few billion dollars

of credit investments on the

long and short side. We

run a pretty concentrated

book. We're not the sort

of investors that want to

sprinkle our assets across

100 different ideas. Our 10

biggest positions represent

the vast majority of the

credit portfolio, so we

know those 10 positions

extremely well and we have

very high conviction in

them. I can assure you that

as they're trading lower,

with very few exceptions,

we're not selling them and

running for the exits, we're

buying more. And when

they trade higher we try and

remind ourselves of the

need to have the discipline

to start to sell things as the

risk/reward becomes less

favorable because of price

moves. This buy and sell

discipline sounds pretty

simple, yet all of us know

that it’s a lot easier said

than done. We try to use

the group dynamic to re-

mind ourselves of that on-

going challenge and to make

sure that we don't get

caught in a trap where we fall in love with our own

positions.

G&D: You mentioned at

the CSIMA Conference last

year that it's very important


cause uncertainty is some-

thing investors will pay to

avoid – sometimes pay a

large amount. We love

situations like Lehman which

we call “high uncertainty,

low risk.” In those few

weeks after Lehman filed,

any person's analysis of

what the ultimate recovery

would be on those bonds

had enormous holes in it.

Every good analyst who was

looking at that situation had

dozens or possibly hundreds

of unanswered questions.

But we knew these would

eventually get answered

over the coming months,

quarters, or years.

What's interesting about the

process, and about the dis-

tressed asset class, is that

occasionally you'll be given

an opportunity to buy

something at a price where

even though you have a

hundred unanswered ques-tions, you realize that re-

gardless of what the an-

swers are, you probably

can't lose a lot of money,

and most of the time you

will make a little or a lot.

This obviously assumes that

you correctly understand

the capital structure, which

is key in distressed invest-

ing. Some people looked at

a Lehman Brothers holding

company bond trading at

nine cents on the dollar and

thought about the fact that

if you deconsolidated the

balance sheet and calculated

what the assets of the hold-

ing company were, which

included individual assets, as

well as tens of billions of

dollars of intercompany

receivables from other Leh-


“...uncertainty, to

us as distressed

investors, is our

friend, because

uncertainty is

something investors

will pay to avoid –

sometimes pay a

large amount. We

love situations like

Lehman which we

call ‘high

uncertainty, low

risk.’”


Daniel Krueger

and build the model very

early in the process. If I ask

you to analyze a bond that's

trading at 52 cents on the

dollar, and let's say it's a

company that makes TVs,

your first inclination is to

read a hundred things about

the company and go talk to

them and do a bunch of calls

and other stuff. That's all

important work to do, of

course, but I might suggest

to you that you should do a

little bit of work first, and

then you should start to

think about what's going to

make that price look cheap

or expensive. Think about

the variables that go into

the analysis: sales growth,

margins, capex, whether

they win or lose a contract,

things like that, and then

build your valuation model

in Excel, and think about

what the blue assumption

cells are. Without doing a

lot of hard work, you won’t

yet have good views about

what the right numbers are

to plug into your blue as-

sumption cells, but you'll

then go out and talk to the

company and be able to ask

targeted questions that spe-

cifically address the blue

cells. Over time the model

will evolve and become

more refined, and you’ll be

building on earlier work and

making improvements, not

just gathering more facts.

What I found in my time

doing this and going to con-ferences or sitting in small

group meetings, is that a lot

of people will have an hour

with the CEO and ask about

a lot of industry jargon that

could only possibly matter if

you knew absolutely all

there is to know about eve-

rything else in the universe,

and these were the last few

things you didn’t know. But

most of the time there's

two or three big things that

really matter and it makes

sense to focus the research

effort there.

In distressed, specifically,

sometimes you can have a

situation where the out-

come is dependent on a

single variable. For exam-

ple, does the intercompany

loan exist between Subsidi-

ary A and Subsidiary B? It's

either there or it's not, and

if it's there your bonds are

worth par, and if it's not

your bonds are worth zero.

In that scenario, does it

really make sense to ask

why ARPU at the holding

company was down 2% in

the third quarter? That’s an

exaggeration, of course, but

the point remains the same.

We also do a lot of primary

research. It's a cliché obvi-

ously, but then again there

are a lot of things in invest-

ing that people can agree

are important but which

they don't actually do. It's

not enough to just hear

from the sell-side that a

certain contract has very

loose language surrounding

the termination rights of a

large customer. You need

to go find that contract, if

it's in the public domain, and you need to read it. Maybe

you need to ask a lawyer

who's an expert in contract

law to read it as well and

give you his or her opinion,

especially if that's a big part


to stick to your investment

process. Could you de-

scribe Owl Creek’s invest-

ment process and how you

built it over the years?

DK: Generally speaking,

we're big believers in the

notion that you need to

focus early on in the analysis

on the major drivers of

what's going to make or

lose you money in the in-

vestment, and avoid the

temptation to simply go out

and gather a lot of data.

The reason I say that is not

only because it’s a waste of

time to do the latter, but in

the worst examples, extra-

neous data are a red herring

that can cause a person to

draw an incorrect conclu-

sion. There’s an interesting

book written by the CIA for

their internal use that talks

about this concept. The

book can actually be read

online for free on the CIA’s website – just Google “CIA

intelligence analysis book”

and you should be able to

find it. In it, it describes

how the human mind can

keep very few concepts in

mind at any one time. As an

example, the book asks the

reader to try to multiply any

pair of two-digit numbers in

one’s head, say 47 X 63.

This is a task that is easy to

do with a pen and paper but

is tricky to do in one’s head

because it’s hard to keep all

the pieces of the puzzle at

the forefront of one’s mind

together at the same time.

In that regard, what I say to

the students in my class as a

tip, and something that we

do around here, is to try


“This buy and sell

discipline sounds

pretty simple, yet

all of us know that

it’s a lot easier said

than done. We try

to use the group

dynamic to remind

ourselves of that

ongoing challenge

and to make sure

that we don't get

caught in a trap

where we fall in

love with our own

positions.”

Daniel Krueger

etc. – these are things for

which you need a special

toolkit to analyze. You

need to be willing to invest

the time to look through all

of the documents and, let's

not forget, this is all on top

of the valuation work that

every analyst would need to

do to analyze an equity. So

you need to be skilled at

valuation, but you also need

to be strong in your under-

standing of all of the struc-

tural aspects of distressed

investing. Then, if that

weren't complicated

enough, you need to under-

stand the motivations of

different people: What

does the LBO sponsor want

to do? Do they want to

extend their option on their

out-of-the-money equity or

file the company tomorrow?

What currency might they

have with which to get a

deal done with creditors?

What does management

want? What do employees

want? What do competi-

tors want? How are com-

petitors going to react if this

company goes into bank-

ruptcy? For example, one

of our current investments

is in an industrial company.

A few years ago when the

company was distressed and

their EBITDA was negative,

their competitors went out

of their way to lower prices

to make it that much worse

and try and force the com-

pany to liquidate. The whole industry got screwed

up because of these pricing

actions. That didn’t work

and the company is still in

business today. Pricing is

now going through the roof

in that industry, even in a

mediocre to bad economy,

because it has a lot of catch-

ing up to do.

Another thing we do as part

of our investment process is

remind each other to tune

out the market noise that a

lot of us have been tacitly

trained to tune in. I think a

lot of people mistakenly

think the task in investing is

to try to predict in which

direction market prices will

go next. It’s a subtle differ-

ence, but I think it’s a mis-

take from the start to think

about it that way, as op-

posed to thinking about

potential outcomes and the

payoff structure across that

range of outcomes. What

the great investors that I

respect most recognize is

that the market is not some

wild beast in need of being

tamed, but that mispricings

in the market are what cre-

ate the opportunities. And

if your analysis causes you

to have a certain view, long

or short, you cannot expect

that every day, or every

week, or even every year

you will be rewarded for

your view. We try to use

our team environment to

remind ourselves of that,

and it’s easier to stick with

one’s conviction when you

have a lot of smart people

around you also buy into

the investment thesis, as

opposed to being alone in

your view.

G&D: Can you talk about a

current investment idea that

you like?

DK: There's a company


of the risk/reward.

The process for analysis in

distressed is very tedious,

very labor intensive, and

very boring. Sure, parts of

it can be action-packed, like

when you're sitting in court

and the judge walks out to

give you the answer to the

key question on your invest-

ment, and you know the

bonds will move 20 points

in a few minutes, you’re just

not sure if it will be up or

down. But to get to that

place you need to have read

two credit agreements, 16

indentures, understood the

financial covenants back-

wards and forwards, mod-

eled out the company's op-

erations quarter-by-quarter

for the next eight quarters

to understand exactly when

they'll run out of cash,

looked through 8-Ks, pro-

spectuses, regulatory filings

to look for intercompany

loans or special dividends that could have been paid

up or down in the struc-

ture, etc. We're generally

looking at big organizational

structures that have a lot of

different pieces, which in-

creases the complexity and

workload, but also maxi-

mizes the chances of finding

mispriced securities.

Take a company like TXU.

This was the largest LBO of

all time, has a huge amount

of debt, multiple layers of

the capital structure

(subordinated, senior, and

secured) at multiple differ-

ent subsidiaries with cross-

guaranties, funds flows in

many different directions,

tax issues that arise from

the corporate structure,


“I think a lot of

people mistakenly

think the task in

investing is to try to

predict in which

direction market

prices will go next.

It’s a subtle

difference, but I

think it’s a mistake

from the start to

think about it that

way, as opposed to

thinking about

potential outcomes

and the payoff

structure across

that range of

outcomes.”


Daniel Krueger

the company, and we cer-

tainly didn’t believe that that

liability was fictitious or that

it should be ignored. But

what we did recognize was

that the liability was not

going to “mature” and be-

come payable anytime soon.

In that respect, we viewed

our near-dated bonds as

quasi-senior to these liabili-

ties. Over time, people

would sue these companies

and drain out cash, and,

indeed, you could see in

their historical financial

statements the cash coming

out of these companies.

What we liked about this

dynamic and the risk/reward

of the position at the time is

that their assets were

largely unencumbered,

meaning they had not been

pledged as collateral to

other lenders, and, thus, the

company was free to use

these assets however it

wanted. We reasoned that

one option for the company

was to sell those assets and

use the proceeds to pay our

bonds as they came due.

Another option was to get

us to voluntarily extend our

bond maturities into the

future if they granted us the

assets as collateral. The

latter was a deal we would

have done because we

would have gone from own-

ing unsecured bonds with a

lot of downside in the event

of a default to being secured

and very well protected.

Ultimately, the path chosen

by the company was one

where the assets were

pledged to the banks to get

them to extend their ma-

turities a number of years.

As soon as that was done it

cleared a pathway for our

bonds to get repaid at par

upon maturity.

Fast forward to today – what we own now is that

bank debt which got ex-

tended, which is a different

bet. The original idea was a

liquidity bet where if we got

it wrong we were going to


called Aiful where we own a

lot of debt. It's a Japanese

company that does con-

sumer finance. They pro-

vide consumers with small

micro-loans, generally

equivalent to a few thou-

sand dollars. This business

doesn't exist in the U.S.,

where credit cards serve

this purpose. The back-

ground here is important,

so let me spend a couple

minutes on that. The rea-

son this company was inter-

esting to us initially was be-

cause they got into trouble

a number of years ago when

the Supreme Court in Japan

ruled that Aiful and certain

competitors had been

charging an interest rate

above the legal limit. You

might ask yourself why they

would do something that's

illegal. In Japan, there are

different interest rate caps

based on different types of

businesses and these com-panies always pushed the

envelope in terms of what

category they fell into. The

Supreme Court came back

and said, "You're wrong and

you've been acting too ag-

gressively all these years."

Overnight, giant contingent

liabilities popped up for

these companies because

their former customers

would now be able to sue

them to recover damages

for this excess interest. The

size of this new liability

caused Aiful’s bonds to

eventually trade down as

low as the 30s around the

summer of 2009, for bonds

that were maturing in a year

or two.

We didn't necessarily love


“You need to be willing

to invest the time to

look through all of the

documents and, let's

not forget, this is all on

top of the valuation

work that every analyst

would need to do to

analyze an equity. You

need to be skilled at

valuation but you also

need to be strong in

your understanding of

all of the structural

aspects of the distressed

asset class. Then, if

that weren't

complicated enough,

you need to understand

the motivations of

different people...”

Pictured: Bruce Greenwald

at Graham & Dodd Breakfast

in October 2012.

Daniel Krueger

capped at par plus interest;

i.e. the shareholders are

getting that 67% upside.

Lately, in this environment,

we love buying 1st lien bank

debt. It's very comforting

to know that when you're a

secured creditor, you are

first in line and that, almost

always, you will get some

recovery on your paper

because it's highly unlikely

that the residual recovery

value on the assets after

bankruptcy fees and liquida-

tion fees would be zero. So

if you’re comfortable that

you’ll have some recovery in

a worst-case scenario, then

the upside/downside analysis

becomes really important.

What we say to each other

around here is that it's only

with the benefit of under-

standing your downside that

you can start to dream

about the upside. For ex-

ample, if you have 1st lien

bank debt at 50 cents on

the dollar, and you think the

ultimate recovery can be

somewhere from 30 to 90,

you would probably buy it

because your upside is 40

points and your downside is

20 points, so you have a 2-

to-1 upside/downside ratio.

Your expected return, as-

suming a normal distribu-

tion, is +20% (from 50 to

60). Now imagine that, on

no fundamental news, the

bank debt trades down 20%

to 40 – your upside/downside is now dramati-

cally different, even though

the price is down “only”

20%. Think about it, from

40, you've got upside of 50

and downside of 10, so your

upside/downside has im-

proved from 2-to-1 to 5-to-

1. However much you liked

it at 50, you should really

love it at 40. I think a lot of

people miss this relationship

because they are overly

focused on their base case

outcome and the return

that one scenario would

generate rather than think-

ing about the range of possi-

ble outcomes. If you're not

thinking about how much

capital you have at risk, i.e.

the downside, then I think

you're leaving out a very

important part of the equa-

tion.

G&D: What is another

investment that you like

currently?

DK: Sometimes distressed

opportunities come in the

form of equities, and we’ve

played a lot of distressed

equities over the years. We

like buying out of the money

options at a cheap price,

and that’s what you get to-

day owning Leap Wireless

equity. In fact we would

argue it’s not even “out” of

the money. Leap is a wire-

less company that trades at

a little over $6 a share. The

market value of equity is

around $500 million, but

that represents only a sliver

of the total enterprise value.

What we love about this

idea, and the reason we

bucket this as a credit idea,

is that you need to under-stand the capital structure

and the liquidity of this com-

pany in order to understand

the risk/reward. We think

the liquidity profile is decent

enough that it doesn’t need


get creamed in terms of our

recovery, but where we

thought our probability of

getting paid off at par was

good enough to warrant the

downside risk. Today it's

the opposite – it's a valua-

tion bet, not a liquidity bet,

where we think our down-

side is limited even in the

worst case outcome. We

think that the assets of this

company, in our base case,

should create enough value

for this bank debt to get

back par. In addition to

that, the fundamentals of

the company have been

improving because the cash

outflows from the excess

interest liabilities have been

coming down recently. We

think that the market has

been overly cynical about

the ability of this company

to dig itself out of its hole

operationally. There’s a

maturity date in the summer

of 2014, so you’ll eventually get an answer to the ques-

tion. In our view, it has

very good downside protec-

tion because it is secured

debt, and you've already

built in a large margin of

safety just in the discounted

price from par down to 60,

where it trades today. The

upside/downside is very

compelling, meaning you can

make enough money on the

upside owning it at 60 – i.e.

+67% on your money – to

justify the downside risk.

That's very distinct from

buying a bond at 100 cents

on the dollar, where your

valuation work may indicate

that you’re “covered” on

valuation by 67%, but you

don’t keep that upside be-

cause a bond is always


Pictured: Whitney Tilson

of T2 Partners LLC at

CSIMA Conference in Feb-

ruary 2012.

“...it's only with the

benefit of

understanding your

downside that you

can start to dream

about the upside.”


Daniel Krueger

So we’ve got a highly vola-

tile asset where we’ve made

a bet in a small part of the

capital structure and we

have a long period of time

to find out how things end

up. So, figuratively speaking,

if we roll the “spectrum

valuation” die and it hits on

one of the upside cases, we

should make multiples of

our money owning this eq-

uity. You can do this math

for yourself and you'll see

pretty clearly that you can

make two, three, four, five,

six times your money in

scenarios that are not pie in

the sky. Plus, we get to roll

that die multiple times, given

the company’s liquidity. If

we’re wrong, the stock may

go to zero, but we believe

even that is questionable

given management’s expec-

tations of turning the corner

and getting to positive free

cash flow. The debt trades

around par, at least for now,

so raising some money in a

debt financing is another

option for the company if

they choose it. We would

never make this a giant posi-

tion in our funds given the

downside risk. Rather, we

would size it so we can live

to fight another day if we

roll snake eyes. The point

of portfolio construction is

to have enough of a mix of

these in your portfolio

where over time you should

do pretty well if you’ve

properly analyzed the prob-abilities of various outcomes

and how much you make or

lose in each scenario.

G&D: What do you think

about the management team

there? The company has a

ton of spectrum that it is

not using and it seems sur-

prising that the management

team has not tried to

monetize it sooner given its

leverage profile.

DK: Actually, my under-

standing is that over the

past couple of years the

company has sold a signifi-

cant chunk of out-of-

footprint spectrum to raise

liquidity, so I don’t immedi-

ately agree with the premise

of the question. And as I

said, we think the company

has a decent liquidity run-

way. Let's say we’re wrong,

though. The other possible

path for this company is that

they go into bankruptcy. As

I say to my students on the

first day of class every year,

bankruptcy has a negative

connotation in society, but

bankruptcy and Chapter 11

exist for a reason. It exists

to allow a company to tran-

sition out of its old, bad

capital structure into a new,

more manageable capital

structure as smoothly as

possible, as well as restruc-

ture operations via renego-

tiation of leases, supply con-

tracts, union agreements,

etc. So if Leap went into

bankruptcy, theory tells you

that creditors will get into a

room and negotiate a plan

of reorganization, vote it

through, and then come out

of bankruptcy and continue

along its path of operations. But another thing that fre-

quently happens in bank-

ruptcy is that the assets get

sold to the highest bidder.

If that happens, and if you

go back to that bottom-up


to file for bankruptcy any-

time soon, and you’ve got a

very large shareholder as

Chairman of the Board, so

you shouldn’t see manage-

ment proactively filing the

company to the detriment

of shareholders. So our

starting point is that we’ve

got an option that will sur-

vive for at least a few years.

Then we think about what

our asset is and what it

could be worth in different

scenarios. A lot of people

like to look at EBITDA mul-

tiples for this company, but I

think that’s really missing

the point, because Leap’s

most important asset can-

not be discerned on the

income statement, but

rather on the balance sheet.

It’s not how much EBITDA

they generated over the

past 12 months, it's the

spectrum that they own, as

well as the subscriber base that they have and all the

plant and equipment that

they've accumulated over

time. If you think about it

that way and then you rea-

son that other people are

buying and selling the stock

based on EBITDA multiples,

it strikes you that you may

have something interesting

to look at here. We’re not

the world's leading experts

on spectrum and we’re not

going to pretend to be, but

we know enough about it to

know that most people are

in the same camp as we are

in, even if they don’t admit

it to themselves. The

traded values of spectrum

over time have been all over

the map.


“[With Leap

Wireless equity],

you can do this

math for yourself

and you'll see

pretty clearly that

you can make two,

three, four, five, six

times your money in

scenarios that are

not pie in the sky.”

Daniel Krueger

nize that no amount of

work can make an opportu-

nity appear in front of you.

The best one can hope for

as the reward for a lot of

hard work is to uncover

opportunities that already

exist, but that is not a given

upfront. The reason I men-

tion this is that we try not

to get too wrapped up in

trying to predict what the

future opportunity set will

look like. We find that do-

ing so can sometimes cause

additional, unnecessary

pressure to trade.

The measure of how attrac-

tive the opportunity set is at

any given point in time is

how much stuff is getting

into the portfolio. Right

now we’ve got over 60% of

our assets invested on the

long side in credit, and

we’ve also got a lot of expo-

sure on the short side, so

clearly we are finding plenty

to do. Remember that even

when the default rate is low,

as it has been recently, you

can still have situations

where companies are get-

ting into trouble but not

defaulting, which creates

opportunities for very high

returns within a defined

period of time – i.e. owning

stressed bonds to maturity.

Like I said before, we run a

very concentrated credit

book. You don’t make

more money by owning more names, you make

more money by owning

better names. So I don't

worry that we're not going

to be able to find 10 to 20

high-conviction ideas to

own at any one time, not

including a lot of other good

short ideas, especially when

you think about the fact that

we're a global investor that

can invest in any part of the

world. Today, we’ve got

roughly 40% of our credit

portfolio invested in situa-

tions outside the U.S. on

the long side.

G&D: Do you utilize credit

default swaps (CDS) and, if

so, how?

DK: We tend to use CDS

a lot on the short side. Oc-

casionally we use it on the

long side as well. And

sometimes we do both, on

the same company, by using

what's called the “CDS

curve” to make very precise

credit bets at some precise

point in the future. The on-

the-run CDS contract that

most people quote is the

five-year contract. This

represents how much you

have to pay per year to buy

protection against the de-

fault of a company for five

years. You pay the same

amount each year for five

years, and if a default occurs

within the five-year period,

then the owner of protec-

tion gets the benefit of get-

ting 100 cents on the dollar

for the notional amount,

and the protection holder

returns the post-default

value of the bond to the

party who sold the protec-

tion. But think about it: why five years? It’s a totally

arbitrary number. If you

were properly analyzing the

credit risk of a company,

you should be able to form

a view of the credit profile


valuation work around the

spectrum and other assets,

you can certainly build a

case for why this stock

might be worth a lot of

money in a bankruptcy.

GGP is an example of a

stock that came out of

bankruptcy with substantial

value. So it wouldn’t be the

worst thing if this company

was on the cusp of bank-

ruptcy and the market in-

correctly traded the stock

at pennies on the dollar

because it equated bank-

ruptcy with a worthless

stock. Clearly, you should

be adding a lot more stock

in that scenario if the analy-

sis hasn’t changed much and

if you thought the risk/

reward was good at $6 per

share.

G&D: As a guest lecturer

in Columbia Business

School’s Special Situations

class recently, Howard Marks showed several

charts of how surprisingly

consistent the high-yield

market cycles are. We've

been in a period of a lot of

high-yield issuance and rich

valuations for a while now.

How are you positioned or

thinking about taking advan-

tage of the eventual oppor-

tunities in that market?

DK: We don't play very

much at all in the new issu-

ance market. We view that

as our future supply of dis-

tressed credits. We've seen

this movie before and How-

ard Marks is telling you a

story of how it ends – it

usually doesn't end pretty.

We don't disagree with that,

but it’s important to recog-


“We don't play

very much at all in

the new issuance

market. We view

that as our future

supply of distressed

credits.”

Pictured: Daniel Krueger

at CSIMA Conference in

February 2012.


Daniel Krueger

September 20th of 2013 for

which we paid 87 cents on

the dollar.

So why did we do that? We

did that because this is a

distressed company with

bank debt trading at dis-

tressed levels, and we think

that there's a reasonable

probability that in the next

few months, the auditors

will go in to do their review

and they will look at the

company's liquidity profile

and projections and say “no

clean opinion.” If that hap-

pens and they don't get a

clean opinion in their 10-K,

that would be an event of

default under the bank

agreement. We find it very

unlikely that lenders would

not use that as an opportu-

nity to push the company

into bankruptcy – and for

good reason – because this

company pays out an enor-

mous amount of money in

coupons to junior creditors

every year. And every time

a dollar goes to a junior

creditor, that's a dollar less

that the first-lien secured

creditors get to keep upon

a bankruptcy filing. So we

think they would love to use

that as a lever to push the

company in.

The timeframe for that de-

fault exists before the expi-

ration of our June protec-

tion, and if there is a default,

our short and long positions cancel each other out and

we keep our 13 points. On

the other hand, if the com-

pany gets a clean opinion,

then it will keep chugging

along – we don't think

there's any material risk that

they bust covenants due to

financial performance before

the end of the third quarter.

In that case, the company

would survive past the expi-

ration of the CDS that we

sold in September, so we

would again keep the 13

points, as both the contract

we bought and the contract

we sold would have expired

worthless. So we're fine

with the company defaulting

before June, defaulting after

September, or never de-

faulting. If the company

defaults in July, of course,

we have a problem. But

that's a calculated risk we

are taking, and we've sized

the position accordingly. I

wouldn't advise you to put

your entire 401K into this

one trade, but within a

portfolio of a bunch of dif-

ferent event-driven ideas,

it's a good one to have be-

cause we think the ability to

earn the equivalent of 15%

for three months of risk, or

the equivalent of 75% on an

annualized basis, is a mis-

priced opportunity given the

facts here. As we say

around the office when try-

ing to illustrate the risk/

reward of a binary-outcome

idea, if we put this same

trade on a hundred times

over our careers, we will

have done very well, even

though not every time will

we have made money.

G&D: Could you describe your strategy on the short

side and how it’s different

from your strategy on the

long side, if at all?

DK: In terms of doing the


within discrete buckets of

time.

Nowadays, a lot of traders

will trade CDS contracts

that are four, three, two,

and one years out, and

sometimes even shorter, in

addition to the more cus-

tomary five-year contract.

That's very interesting to us

because in very complex

situations you could form

the view, for example, that a

company’s credit risk is

largely in the twelve months

between three and four

years from now, but not

before or after that. This

sort of unnatural credit

curve could exist for a lot of

reasons, such as how much

cash the company has on its

books versus the cash burn,

whether it has an unfunded

revolver, when it might vio-

late the financial covenants

in the credit agreement,

whether it has a big subordi-

nated bond maturity in a few years, whether it has a

big customer contract that

might roll off, etc.

I won't mention the name,

but right now we have a

position in our books where

we own protection through

June 20th of 2013 that we

bought for 18 points up-

front, but we simultaneously

sold protection through

September 20th of 2013 at

31 points upfront. We’re

long the credit risk of this

company for only three

months, but we got paid 13

points (the delta between

31 and 18) to take that risk.

So we've essentially con-

structed a three-month

bond that is issued on June

21st of 2013 and matures on


“So we've

essentially

constructed [using

CDS contracts] a

three-month bond

that is issued on

June 21st of 2013

and matures on

September 20th of

2013 for which we

paid 87 cents on

the dollar.”

Daniel Krueger

if something bad happens –

maybe supply and demand in

the steel market gets out of

whack because of all the

new supply in China, or

maybe there is a bad global

slowdown – we would be

paid handsomely. We don't

pretend like we can predict

with certainty what's going

to happen, but we own an

option on something hap-

pening in a realm where

there's a lot of inherent

volatility due to operating

leverage, financial leverage,

and cyclicality.

The one pushback we al-

ways get on this idea is that

in Japan, whenever compa-

nies get into trouble, the

banks just come in and bail

them out. They say that the

banks don't really do any

credit analysis, it doesn't

matter what a company’s

leverage is, what its cash

flow is – if it’s a big indus-

trial company, it asks for the

money and gets it. First, we

disagree that this is always

true, as we've seen some

Japanese companies go into

insolvency proceedings.

Japan Airlines and Elpida are

examples. I also feel like in

an environment where

there's already a tough eco-

nomic landscape, to think

that the system needs to

continue to exist to subsi-

dize the highest-cost pro-

ducer of steel in the world

doesn't ring true when viewed through an eco-

nomic lens.

We may get this wrong, and

if we do we will have lost a

couple of hundred basis

points on the notional posi-

tion per year for a couple of

years, and we'll take the

position off and move on

with life. But if any of these

positions end up working,

we'll make many multiples

of what we're investing in

this trade per year to keep

it on. On the short side the

analysis is the same but usu-

ally the attraction is that

we're looking for problems

that the market doesn't give

much weight to today that

we think should have a

higher weight.

G&D: You’ve been teach-

ing at Columbia Business

School since 2006. Could

you describe the genesis of

your class and whether

you’ve seen any change in

the students since you be-

gan teaching it?

DK: When they first asked

me to teach the class, I said,

"No thanks. I think that's a

poor idea for a class be-

cause distressed investing is

really the intersection of

value investing (I'm not go-

ing to compete with Bruce

Greenwald and all these

other fabulous professors

on value investing), bank-

ruptcy law (no one can

compare to Harvey Miller,

who teaches that at the Law

School), and turnaround

management (again, some-

thing that is already taught

very well).” They asked me

again a year later, and I rea-soned that rather than try

and teach those things, I

would just be the professor

who gathers it together and

puts it in a package that

involves making money –


analysis on the short side,

it's the same as it is on the

long side. As you might

guess, we tend to short

companies that aren't yet

perceived as stressed or

distressed. Occasionally

we'll press a short when the

company has already bro-

ken, but most of the time

we will simply buy CDS on

companies where we fore-

see some higher probability

that things will get really

messy than what is reflected

in current credit spreads.

Let's remember that in

credit – to oversimplify it –

you are analyzing only two

questions: First, what is the

probability of a default, and

second, if there is a default,

what will the recovery on

the debt be? Clearly the

answers to those two ques-

tions depend on a thousand

other questions being an-

swered, but if you're not

thinking about it that way then you're not really doing

credit analysis in my view.

So as credit investors, and

especially as distressed in-

vestors, we're built to ana-

lyze and opine on tail out-

comes.

Japanese steel companies,

on which we own a lot of

CDS, are extremely lever-

aged, and bankruptcies in

Japan tend to produce hor-

rible outcomes. I think the

average historical recovery

over a long period of time

has been roughly 13 cents

on the dollar, much worse

than in the U.S. where it's in

the 40s. The steel industry

as we all know is a very

cyclical industry. By owning

CDS we own an option that


“Let's remember that

in credit – to

oversimplify it – you

are analyzing only

two questions: First,

what is the

probability of a

default, and second,

if there is a default,

what will the recovery

on the debt be?

Clearly the answers

to those two

questions depend on

a thousand other

questions being

answered, but if

you're not thinking

about it that way

then you're not really

doing credit analysis

in my view.”


Daniel Krueger

think it will be almost im-

possible to teach these 40

to 45 students about dis-

tressed investing because

it’s a very daunting topic and

something that, in a lot of

ways, you really can't teach.

You learn it on the job over

a number of years. I still

learn something new every

day, which is why I like my

job so much.


advice that you would give

to students interested in

distressed investing?

DK: My advice for business

school students generally is

that the most important

asset you have at this stage

in your career is your hu-

man capital, not your finan-

cial capital. Occasionally I

see people worrying about

who's going to pay them the

most or which firm has the

most glamour attached to it,

which I think is a mistake.

In a Warren Buffett-style of

value investing, if your most

important asset is your hu-

man capital, then you need

to try to set it on a growth

trajectory with a double-

digit CAGR for a number of

years. After a while, that

will grow into something

powerful, and then you’ll

have many more options.

The way you do that is to,

first of all, find a job working

with people who you like

and in an environment where you can do meaning-

ful work and learn a lot.

Certainly that's what I got

when I joined Jeff here at

Owl Creek. It was Jeff, me,

and one of my classmates

from Columbia, Shai Tam-

bor. It was just the three of

us on the investing side and

we were trying to make a

go of it. In that sort of sce-

nario, the world is your

oyster.

In distressed specifically, like

I said before, you learn on

the job. A lot of people in

distressed have a broad

array of different back-

grounds: turnaround advi-

sors, lawyers, bankers, sell-

side analysts, private equity

investors, etc. So if you're a

second-year student at Co-

lumbia Business School to-

day and you think you defi-

nitely want to go into dis-

tressed, don't think that if

it's not your first job out of

business school that you

can't find your way in even-

tually. When we hire peo-

ple to come in at the analyst

level here at Owl Creek, we

expect them to have a pas-

sion for investing and a lot

of raw horsepower, but

they don't need to be Seth

Klarman their first day on

the job. They need to be

people who are smart, who

have the right skill set, and

who we think can develop

into good investors over

time.

G&D: Thank you very

much for your time, Mr.

Krueger.

making good risk/reward

decisions.

I tell my students that, first

of all, I truly believe the

class and the skill set of dis-

tressed investing is some-

thing that doesn't only apply

to distressed investors. I

think it's a very useful class

to have taken if you're going

to work in private equity or

if you're going to work in

equities. How many times

have we seen equity inves-

tors and equity sell-side

analysts get caught in a trap

because they didn’t look at a

company's capital structure

or think about its liquidity?

If you're just looking at a P/E

multiple, you're not captur-

ing a lot of other things that

are important to your stock.

Areas such as advisory and

consulting at some time or

another also touch the dis-

tressed landscape. Even if

you're the CEO of a com-

pany and your company never goes into bankruptcy,

your competitor might. If

this happens, what is the

competitor going to do?

Who's going to buy them?

Are they going to shut all of

their plants? Are they going

to slash their labor costs

and use that to under-price

you? There are a lot of

different things that could

happen. So these are all

things that pop up in dis-

tressed and pop up in my

class.

I've always been very im-

pressed by the students in

my class. I'm always very

excited to see the progres-

sion from the first day of

class to the last day. At the

start of every semester, I


“In a Warren

Buffett-style of

value investing, if

your most

important asset is

your human capital

you need to set it

on a growth

trajectory with

double digit CAGR

for a number of

years. In a number

of years that will

have grown into

something that's

powerful and useful

and something that

will be even more

important to you.”

Frank Martin

a fighter or attack aircraft

off carriers. I defaulted into

my investment management

career because I flunked the

flight physical three times

due to an astigmatism,

which is a minor eye

disorder. So I didn’t lend

Coke machines or conduct

other for-profit endeavors

as the child prodigy, Warren

Buffett, did.

Finally, perhaps as a means

of compensation, a latent

and almost insatiable desire

for knowledge and wisdom

emerged and I became an

avid reader. I suspect I read

at least 30 hours each week,

between books, periodicals,

and the current news. I

avoid all the social media

sites but am fastidious about

emails.

G&D: Your firm is located

in Elkhart, Indiana, far away

from New York City, the

hub of the investing world.

In what ways has this been a

positive for you?

We call Elkhart ‘Omaha

East’ [laughs]. I can’t think

of a better place to be than

in Elkhart, or a better place

not to be than in New York.

I don’t get the typical

distractions in Elkhart. We

have no watering holes, at

least so far as I am aware. I

haven’t been to a bar in my

life for after-work drinks. I

think it’s a lot easier to be independent without the

herd pushing you toward

the mediocre middle. I

know for sure it’s much

easier to think

independently. I control

most of my input because it

primarily comes in print

form. I also watch Bruce

Greenwald, your professor

at Columbia Business

School, from time to time

on video, along with other

investors I respect such as

Kyle Bass and David

Einhorn.

Another positive is that my

commute is 10 minutes.

Compare that to how long

the average New Yorker

spends getting to and from

work, and you get an idea of

the competitive advantage I

have. But I also have

another edge. I get up

seven days a week at 4:30 in

the morning. The first four

hours are the most

productive in my day.

There’s an old adage that

says, “An hour in the

morning is worth two any

other time of the day.” In

terms of staying current, at

4:30 I begin with the

internet versions of the

Financial Times and The New

York Times. I then read The

Wall Street Journal and sign

onto Bloomberg early to

read the news and check

the global markets. I usually

get this done before 5:30 in

the morning. The Economist

is on my list, but not as a

daily read. Given the

abundance of information,

the biggest challenge for all

of us is to separate the

wheat from the chaff. By

limiting myself to an hour for current news at the

beginning of each day, I

effectively impose a time

filter that forces me to seek

out the meaningful over the

trivial.


After graduating from

Northwestern University in

1964, Mr. Martin served as

an officer in the Navy for

two years. He is an avid

reader, writer, and

philanthropist. He is

founder and chairman of

DreamsWork, a mentoring

and scholarship program

for inner-city children. He

received his MBA with

honors from Indiana

University South Bend in

1978.

G&D: Can you tell us

about your background and

how you became interested

in investing?

FM: As an investment

management major, I took a

course during my senior

year at Northwestern on

security analysis. The

teacher was an adjunct

faculty member, Corliss

Anderson, who was one of

the founders of Duff,

Anderson & Clark, which

was a Chicago-based

municipal bond firm that has

since been broken into

pieces. Anderson was the

perfect mix between the

theoretical and the practical.

He had been in the field,

and he used Graham’s

Security Analysis as his

textbook. It was a

watershed event for me.

But I have to tell you, unlike

a lot of the investors you’ve

featured in Graham &

Doddsville, if I had any

epiphany, it really occurred

in slow motion. I went to

Northwestern primarily to

become a Navy pilot, so I

was a naval ROTC student.

My dream as a kid was to fly


Frank Martin

“We call Elkhart

‘Omaha

East’ [laughs]. I

can’t think of a

better place to be

than in Elkhart, or a

better place not to

be than in New

York. I don’t get the

typical distractions

in Elkhart. … I think

it’s a lot easier to be

independent without

the herd pushing

you toward the

mediocre middle. I

know for sure it’s

much easier to think

independently.”


Frank Martin

CDs yielding 14%, why

would I lock myself into a

20% tax-exempt bond?” As

we know, one of the great

challenges in our profession

is to see beyond the

moment, even though most

people live in that space.

Through sheer persistence

and force of will, I managed to convince some people.

The nice thing about selling

people 20-year tax-exempts,

which were all callable in 10

years, is that they think

you’re a genius for the next

10 years because as rates

came down those high

coupons kept looking better

and better. So I was kind of

a local hero there for a

while. Then, when the

municipal yields fell, the

spreads narrowed. The

M&A world came alive. So

since I was used to doing

these kinds of long-tailed

transactions, it was an easy

transition to M&A. When

Walston failed, I sold our

office to McDonald and

Company in 1974, which

had a strong presence in the

municipal market, and were

guys who I greatly admired

who were very skilled in the

M&A arena. They were

great teachers. One of

those teachers, Mark

Filippell, eventually co-

founded Western Reserve

Partners and I sit on the

M&A firm’s board.

I cut my investment teeth in

the early 1980s; I had to

make one correct decision

at that time – I had to

believe that interest rates

would come down. That

was an easy call, I felt,

because the U.S. Dollar was

clearly the world’s reserve

currency, and in that role,

we simply couldn’t be

running a double-digit

inflation number indefinitely

or we’d lose our credibility

completely. If interest rates

came down, then P/E’s

would come up, and stocks

would be an excellent play. If interest rates came down,

bonds would be an even

better play. I put my entire

retirement plan in 13.5% 20-

year zero-coupon bonds.

That was an automatic 12-


G&D: What led you to the

founding of Martin Capital

Management?

FM: It took me 20 years to

get there! I started in 1966

on the sell side with

Walston and Company. My

mandate was to go out and

sell. The product de jure

was, believe it or not,

Hedge Fund of America. I

was told as a rookie that

Hedge Fund of America was

designed to make money on

the long and the short side.

But I learned in 1969 that

you could actually lose

people money, even with

hedge funds, which left a

really bad taste in my

mouth.

I didn’t like this idea of being

in a position where you

could actually lose people

money as a fiduciary. So I

spent the next 10 years on

the municipal finance side of the business. As interest

rates rose through the

1970s, it was a very fun

business for me. At one

point in the early 1980s, the

lowest-yielding tax-exempt

bond I had in my own

portfolio was 14%. That

was back with 50% tax

rates. So gross that up, and

that’s a 28% equivalent,

which is three times the

Ibbotson return since 1926.

That’s a no-brainer type of

investment.

Since I originated these

financings and had some

access to investors in the

area, I asked them if they

wanted to participate. Of

course, most of them said in

the early 1980s, “Jeez, with


“At one point in the

early 1980s, the

lowest-yielding tax-

exempt bond I had

in my own portfolio

was 14%. That was

back with 50% tax

rates. So gross that

up, and that’s a

28% equivalent,

which is three times

the Ibbotson return

since 1926. That’s

a no-brainer type of

investment.”

Frank Martin

U.S. treasuries when

October 19th hit. I had been

writing for a long time

about the dangers that I had

seen. So even though I was

a startup and didn’t have

that many clients, I was able

to call all of them that night

and say, “Your portfolios

are actually up for the day

because of the flight to

safety.” I got off on a good

foot with my new clients in

1987.

G&D: Given that the

macro environment plays an

important role in your investment style, can you

talk about how you’ve

thought through some of

the significant events of the

past 25 years?

The 1990s were a

fascinating and equally

perilous time because the

public, which had long been

absent from the market as

measured by the ICI fund

flows, came back in spades.

I think there were 5 million

families that were in funds

at the beginning of the

decade and nearly 50 million

at the end. So it became an

increasingly retail-oriented

market. The 1990s were

capped off with the dot com

bubble and the insane

valuations, so during that

time I was mostly playing

defense. Of course, I was

still collecting good coupons

from the tax-exempt bonds.

The year 2000 was a

watershed year for me. I

thought anything technology

-related or dot com-related

was insanely expensive. But

the bifurcation of the

market was clear. I could

buy mundane manufacturing

companies – the ‘main

street’ companies, if you will

– on the cheap. So if you

look at our investment

results from early 2000 to

2001, we were up sharply

while the market was down.

As you can imagine, we fell

behind the markets in the

late 1990s. There was no

way you could keep up with

the near doubling of some

of the technology-related

indices during the height of

the bubble. But we made it

up by going up when the

market went down in the early part of the next

decade. When it comes to

compounding, I’m not sure

everyone understands that

percentage losses and gains

are not equal. I’ve always


bagger without any credit or

duration risk – all in U.S.

treasuries, which then

allowed me to do a lot of

other things. In the 1980s I

had more ideas than I had

money. Three clients and I

bought a 25% stake in a

bank at 50% of book value

that was well capitalized and

returning 15% on equity.

Once again, the math is

pretty simple – 15% on

stated equity is 30% on my

cost. I bought a lot of it,

and it was ultimately a 10-

bagger. We had a few

other ideas like that and I

thought it was prudent to

make big bets because

investors were generally

over consumed with

avoiding risk. In other

words, the antithesis of

today. The 1980s were just

an incredible time to be an

investor. And I hope – and

expect – that someday we

may find ourselves in an environment where risk is

overvalued and return is

underpriced! And this time,

double-digit interest rates

may not be the cause.

When I was 36 (1978), I was

diagnosed with multiple

sclerosis (MS). I knew that

the life of a mergers and

acquisitions banker, which is

all travel and pure madness,

would not be the career for

me in the later stages of my

life. So I went back to

school at night and had a

wonderful time earning my

MBA and the CFA charter.

Just before the market crash

in 1987, I hung out my

shingle. 1987 was beautiful

because I was fully invested

in tax-exempt bonds and


“When it comes to

compounding, I’m

not sure everyone

understands that

percentage losses

and gains are not

equal. I’ve always

managed to avoid

the large losses.

Imagine something

as simple as that

being one of your

secret sauces!”


Frank Martin

you hope to achieve

competitive long term

compounding. Although

most of the time I am a long

-only investor, the financial

system had become so

untethered from reality that

I wound up doing what

Michael Burry later

described as “going long the

short side.” I tried to sell

everybody in the firm on

the idea of buying puts on

the investment banks. As

was thoroughly documented

in Chapter 10 of Decade of

Delusions*, it was

understandably a tough sell.

So I went through the

investment banking section

in Value Line and picked

four or five companies that I

thought were candidates.

Bear Stearns had won the

Investment Bank of the Year

award for three years

running, so I figured that

they had lots of hubris. Like

a superficial Michael Burry, I

read a couple of their high-

yield money market fund

prospectuses from cover to

cover, which was quite a

job. I thought, “Oh my

goodness, these guys are

smoking dope!” So Bear

Stearns was an easy

candidate. Of course,

Lehman was always playing

it a bit fast and loose and

too close to the edge in

terms of leverage, so it was

another easy candidate.

Merrill Lynch was our

custodian before we moved to Fidelity, so I had some

personal experience in

dealing with the chaos at

Merrill. Call it envy, but I,

like Michael Lewis, always

felt that Goldman Sachs was

pushing the envelope as

well. It was a simple call.

Deep out-of-the-money

puts were exceptionally

cheap, unlike today. You

almost couldn’t afford not

to do it. Kyle Bass calls

such situations “asymmetric

bets,” where the payoff is

many times the risk

incurred. They are as rare

as they are profitable.

[*Editor’s note: all of the

opinions/events/decisions and

so on referred to in the

interview were chronicled real-

time in Martin Capital

Management’s annual reports

– several reaching 100 pages

– that became the grist of two

books, Speculative

Contagion (2006) and A

Decade of Delusions

(2011).]

Let’s go back to the year

2000. I looked at valuations

using a crude approximation

of what Bob Shiller turned

into something incredibly

helpful. The Shiller P/E ratio

uses inflation-adjusted data

and 10-year moving

averages of earnings.

Valuations were in the

insane area – they were

much higher than where

they were in the late 1920s.

I looked at the broad-based

inclination to take

unrewarded risks – the

speculative contagion, which

had permeated Wall Street

and particularly the retail

investor. We hadn’t gotten

into the huge leverage problem yet. I believed

then as I believe now that

we were at a secular market

top. If you look at the

Shiller data, these markets

typically don’t clear until the


managed to avoid the large

losses. Imagine something

as simple as that being one

of your secret sauces!

The same thing really

happened later on as we

approached the financial

crisis. It was pretty easy to

see that what I called “the

easy money fool’s rally” of

2003-2007 was going to end

badly. You couldn’t

describe it exactly. Ben

Graham said, “You don’t

have to know a man’s exact

weight to know if he’s

obese.” Like in the early

1980s when buying long-

term bonds, I only had to be

generally right. Anecdotally

you could look at things,

such as house prices, the

impending end-game of

Hyman Minsky’s financial

innovation hypothesis, a

shamefully lax financial

regulatory environment, and

the perverse incentives up and down the food chain,

which included the rating

agencies that became

complicit by abdicating their

role as watchdogs. And the

list goes on. I looked at

structured finance deals, and

the whole idea of

overcollateralization or

redundancies, to the extent

they had any, and the idea of

layering risk in tranches to

get higher ratings struck me

as insanity. I didn’t know it

would end as badly as it did,

however.

I came back from the

Berkshire meeting in May

2007 thinking that Charlie

Munger was right – you

must avoid catastrophic

losses in your portfolio if


Frank Martin

the downside. If our

competitors behave that

way and we understand the

difference between time-

weighted and dollar-

weighted returns, the

“edge” of our sword cuts

two ways!

G&D: Much like in the late

1990s, your defensive

nature served you well during the market run-up

and collapse following the

financial crisis. Could you

describe your defensive

nature and this latter period

a bit?

FM: I would like to think

that being defensive is an

educated conclusion. The

first book, Speculative

Contagion, came out in 2006.

At the time people said to

me, “Gee, I like your book,

but I have no idea how to

pronounce the title.” I

would say to them, “You

wait, in a few years, the

word ‘contagion’ will be

part of the common

vernacular of the trade.”

This is, of course, what has

happened. So the title was

ahead of its time, but I’m

not sure the book was. A

Decade of Delusions was sort

of a capstone in 2011 for

the preceding decade, which

was a decade that I have felt

had been way too risky for

two reasons. First,

valuations had been

stretched, certainly if you

used the aforementioned

Shiller P/E. Second, because

of increased financial

leverage throughout the

world, tail risks had

increased greatly. With that

overhang throughout the

decade, I was thinking to

myself, “Wow, what I don’t

need to do is get blindsided

because we are paid on

performance. I don’t want

to get underwater.” You

can’t afford to get deep

underwater if you really

expect to achieve good long

-term compounding. I’m

invariably defensive too

early as I was then. And I justified that because of the

optionality of cash, the

aforementioned

overvaluation, and the tail

risks that I think people had

not priced in. I hope that


Shiller P/E gets below 10

times, and sometimes

materially below.

Buffett at the same time was

writing about 17-year

cycles, which I had thought

a lot about, and I agreed

with. Around 2000, I wrote

that I wouldn’t be surprised

if a 6% coupon U.S. treasury

would outperform the

equity markets through the

next cycle. Once again, the

beauty is in its simplicity.

Let's say in 2000 you bought

a 6% 20-year zero-coupon

treasury. Today, it’s got

seven years to run. It

would have cost you 33

cents on the dollar. I think

because of the low five-year

rates, it would be selling at

96 cents on the dollar.

That's an internal rate of

return of just under 9%,

versus a sub-2% return,

including dividends, for the

S&P 500. The S&P 500 would have to be at 3,500

to match the zero.

The problem with that is

the institutional imperative.

People don’t pay us to think,

they pay us to act. They

don’t pay you for playing

good defense; they pay you

for playing good offense.

One would think that

everybody understands

Einstein’s great insight – that

compound interest is the

most powerful force in the

universe. We all are aware

of the simple example that a

50% loss requires a 100%

gain to equal things out. Be

that as it may, people would

rather play offense and then

lick their wounds after they

have a bad experience on


“The problem with

[investing in

government bonds]

is the institutional

imperative. People

don’t pay us to

think, they pay us

to act. They don’t

pay you for playing

good defense; they

pay you for playing

good offense.”


Frank Martin

I also think people’s

expectations related to jobs

have been greatly

downsized. People are

thinking much more

rationally. A job is no

longer an entitlement, it is a

privilege. What’s going to

happen, I think, is that the

longer this goes on, the

better our workforce’s

attitude toward laboring is

going to be, and the more

competitive we’re going to

be on the global stage. I

could see a renaissance in

manufacturing in America

because of the traumatizing

events through which labor

has gone. Workers have

reordered their

expectations – we’re not

going to have folks at GM

making, with benefits,

anything comparable to

what they made in the

heydays. I think we’re going

to spend a lot of time

focusing on those areas

where manufacturing can

enjoy a renaissance and

where labor inputs will be

reasonable on the world

stage. I think that’s really

exciting. Matt Ridley’s, The

Rational Optimist, helps one

understand where the

opportunities just might

arise.

On the other hand, profit

margins are peaking. Top-

line growth hasn’t been

there. You can’t cut costs

to prosperity. You

eventually have to have top-

line growth. The economy

continues to struggle. I’m

worried about the fact that

tax revenues have averaged

18% of GDP – true over the

long-term, with a low

standard deviation, and

seemingly impervious to

how high the top marginal

tax rate is – and we’re

spending at a rate of more

than 24%. It’s that issue

that I think we have to address at the legislative

level, which I don’t think has

much of a chance of

occurring for some time to

come.


sometime in the not too

distant future, the markets

will complete what I

consider the ultimate end

phase of a secular bear

market that really began

with the peak in 2000. This

is clearly a minority view.

G&D: In your opinion, are

the market and the

American economy on their

way to being mended and

attractive or does it remain

as “deluded” as it was

during the last decade?

I would ask the question,

can the excesses built up

from the success generated

by a long period of

conservative economics and

deregulation be cleansed in

a matter of six months from

September 2008 to March

of 2009? I don’t think

human behavior works that

way. Most of us need to

have a trip to a woodshed before we begin to mend

our ways. There’s a good

analogy with the labor

market. Labor has been

bludgeoned in part because

of the excesses in the

financial sector. And many

homeowners, who are part

of the labor pool, have also

been suffering greatly. I

think this will be resolved

through a significant

behavioral change. People

will not use their home as

an ATM. They will not use

homes as a way of making a

quick profit. Throughout

my investment life, people

used their home as a way to

build up equity by paying

down their mortgage, not as

a speculative vehicle.


“I would ask the

question, can the

excesses built up

from the success

generated by a long

period of conserva-

tive economics and

deregulation be

cleansed in a mat-

ter of six months

from September

2008 to March of

2009? I don’t think

human behavior

works that way.

Most of us need to

have a trip to a

woodshed before

we begin to mend

our ways.”

Pictured: Mario Gabelli and

David Winters at Omaha

Dinner in May 2012.

Frank Martin

today. That’s why I think

Dodd-Frank is the toothless

tiger. All this leads me to

believe that we’re just

playing games with

ourselves. The bell curve is

a joke, and value at risk is a

concept that is a really lousy

measure of true risk. I think

you’ve got to gross up risk

at the big banks, derivatives

risk in particular. If you do

that today you’ve got

yourself a crisis. So the

world’s financial system

remains in a critical state.

Basel II allowed the

European banks to go to a

2% capital ratio. Is that not

a prescription for disaster?

I just don’t think we’ve

written the final chapter in

this. We are at a critical

state, but I have no idea

what the catalyst is.

G&D: Can you talk about

the investment strategy at

Martin Capital Management?

FM: I would like to say that

we’re a situationally-

sensitive value investor.

Everything is situation-

specific. The situation I’ve

just described is one that

suggests that tomorrow’s

opportunity set may be

better than today’s. So

sometimes you have to play

defense. You’re always

trying to find fish that swim

against the stream, but

shopping in a crowded big-

box store shortly before Christmas is really

problematic. What’s your

edge if you’re piling in there

with everybody else? This is

often a significant failing on

my part – I think I’ve been

so preoccupied with top-

down, especially over the

last decade, that I’ve missed

a lot of layups that I could

have had if I had been just a

little more open-minded and

shorter-term oriented. I’m

like Bob Rodriguez in that

I’ve been very defensive

since the summer of 2010,

and that has not paid me

very well because the

default asset class, for a guy

who’s looking for some

place other than the market

to put his money, doesn’t

yield anything. So for the

first time in my investment

life, there is not an

alternative that actually pays

me something.

But believe it or not, when

it comes to individual

security selection, we are a

bottom-up firm. We’re not

interested in cigar butts;

we’re a classic Buffett-type

investor. We want

companies that we don’t

have to sell unless the

market bids them up to

uneconomic prices. For

example, Gentex is one of

our current holdings.

We’ve actually bought

Gentex twice. I love buying

the same company twice

because you’ve already done

your work. It’s very

efficient. I bought it the first

time in late 2008 and again

recently. The business

performed beautifully during

the recession, but the stock

became too expensive. Then they had some news

regarding their rear camera

display option, which was

negatively received. The

cameras were going to be

placed on the dash instead


Additionally, I do think that

the capital markets have not

gone through any kind of

catharsis of the sort that

labor has. Labor no longer

has a powerful lobby but

capital does. I recently read

that $3.6 trillion of

corporate bonds were sold

by mid-December 2012 –

who’s buying those? Well,

it’s in part the small investor

who’s disaffected with

equities and bound and

determined to get some

yield out of something, so

he’s stretching out the risk

curve and scrambling for

some sort of return.

The shadow banking system

in the United States is $25

trillion, I believe, and $65

trillion globally. Neither

domestically nor globally

have the numbers changed

much since 2007. In the

United States, total assets in

our banking system are $13 trillion. So the shadow

banking system, which is

mostly asset-backed lending,

is double the size of the

regulated lending market.

Ben Bernanke really doesn’t

have as much control over

the financial mechanism as

most of us would like to

think. You would have

thought that the whole

shadow system – the arms-

length securitization system

– would have collapsed, but

the numbers suggest

otherwise. This all tells me

that 2008-2009 wasn’t

cathartic, and that we’re

kind of back to the old

games.

The banking lobby is just

incredibly strong, even



Frank Martin

G&D: Many value

investors tend to avoid

macroeconomic thinking in

their individual stock

selection. Why is it so

important to understand the

top-down perspective along

with bottom-up analysis?

FM: Because I think this is

really a fascinating subject,

and I notice that most value

investors are primarily

bottom-up. I took you

through the decade of

delusions, but let’s go back

to 2006. The 2006

Berkshire Hathaway annual

report came out in March of

2007, and the meeting was

May 5th of 2007. So I’m

reading the annual report

about what Buffett was

looking for in a successor.

Let me read you these two

short paragraphs:

“Over time, markets will do

extraordinary, even bizarre,

things. A single, big mistake

could wipe out a long string

of successes. We therefore

need someone genetically

programmed to recognize

and avoid serious risks,

including those never before

encountered. Certain perils

that lurk in investment

strategies cannot be spotted

by use of the models

commonly employed today

by financial institutions.”

Now I would say that

there’s nothing micro about that, nothing bottom-up.

And then he goes on to say:

“Temperament is also

important. Independent

thinking, emotional stability,

and a keen understanding of

both human and institutional

behavior are vital to long-

term investment success.

I’ve seen a lot of very smart

people who have lacked

these virtues.”

I was reading this and

thinking, “Where’s the

bottom-up stuff in this?”

Was this kind of a quiet

warning to the world that

things were crazy? Based

on his subsequent behavior,

I don’t think it was. But I

think he hit the nail

absolutely on the head.

There are times where

you’ve got to think top-

down when the risks I

mentioned earlier are

present, perhaps in spades.

That’s why I think as I do,

and that’s why I hope that

my job will become

immediately redundant

when we experience the

downside of the cycle. This

is really critical to how this

might differentiate me. As I

say, it’s situational. When

stocks are cheap, and tail

risks are priced in, or we’ve

gotten rid of some of the

tail risks by addressing some

of the still excessive

leverage throughout the

entire system, then you

really won’t have to worry.

The biggest tail risk,

obviously, is still financial,

unless you listen to Leon

Panetta saying that we might

have a cyber Pearl Harbor.

But that’s so abstract that I can’t price it in. But the

“gray” swan risk of another

leg in the financial crisis is

real. While we can’t assign

a probability to it, it’s

nonetheless real.


of in the mirrors on a

couple of their big

customers’ cars. But I

didn’t think that this

development was that

material, and I love the

demonstrated productivity

of their research process.

The stock tanked a number

of months ago, so we took a

big position in it again. I

also really admire the CEO.

The first document I read

on any company is the

proxy statement because I

want to know where the

incentives and rewards are.

Obviously I like owner-

operators, but you don’t

find those in the big-cap

companies. Then you’ve got

to read the 10-K to find out

what the real story is,

because the 10-K is the

annual report without the

adjectives. If you strip out

the adjectives in an annual

report, it looks pretty bland. Of course the 10-K requires

disclosures like risk factors

that you would never put in

an annual report. If you’re

comfortable with a company

after you get through those

two documents, then it’s

time to see if management

squares up with what the 10

-K says. I also always read

five years’ worth of glossy

annual reports, and I always

read them in one sitting.

It’s a great exercise. You

would not believe how

many companies’ reports

are so different year-to-year

that you don’t even

recognize them as the same

company. I want to make

sure that one year is not

inconsistent with the year

preceding.


“But I think

[Warren Buffett]

hit the nail

absolutely on the

head. There are

times where you’ve

got to think top-

down when the

[macroeconomic]

risks I mentioned

earlier are present,

perhaps in

spades.”

Frank Martin

The Crowd, written in 1895

by Gustave Le Bon, is

probably the most

instrumental book in

framing my ability to go

against the grain of

conventional thought and

not feel insecure. Le Bon

basically said that when one

joins a crowd – when one

becomes part of the herd –

he tends to function at a

much lower level. In the

capital markets – because of

the Bloomberg terminal,

because of instantaneous

communications, because

everything is live and online

– we can create

instantaneous synthetic

crowds. This whole

business with ‘the Fed has

our back, that as long as the

Fed is going to keep the

spigots open, you’re not

going to get a bear market,’

is a simple suggestion –

according to Le Bon, the

crowd loves simple

suggestions.

Understandably, it is

incapable of complex

reasoning. Imagine the edge

one has if one simply

disassociates himself from

the crowd.

For example, I think many

investors are misreading

what the Fed is doing today.

Once they submit to the

will of the crowd they are

almost Pavlovian in

responding to the simplicity

of the “Bernanke put” and are thus oblivious to the

long-term consequences.

Somehow this has to be

unwound. Everybody

thinks, “Well we’ll just grow

our way out of it.” Well,

perhaps we will, but given

that we’ve barely begun a

deleveraging cycle that will

impact growth for a long

time, that’s not a bet I’m

willing to make.

At Northwestern I took a

survey course in religion in

which I read the great

theologian Reinhold

Niebuhr’s Moral Man and

Immoral Society and was

enamored with it. It was

my first introduction to

crowd behavior. When

Extraordinary Popular

Delusions and The Madness of

Crowds came along, I

devoured that. The title is

so descriptive and so

timeless; think of how well

it describes the mood of

today. Bob Shiller is a

leading light among a

growing group of behavioral

economists, and his Irrational

Exuberance, published in

early 2000, revealed his

multidisciplinary capacity. I

almost didn’t read the

second edition that came

out in 2005, because it was

essentially a reprint…

except for a rather

fascinating discussion on the

emerging real estate bubble!

What he said in a practical

sense resonated so well

with all the social science

theory I had read. I’m

deeply in his debt. I just

read Daniel Kahneman’s

Thinking, Fast and Slow, and I

think that he and the late

Amos Tversky are some of the great behavioral

scientists. Since nobody in

our industry thinks about

this very much, I think about

it a lot.


G&D: Could you describe

the interaction between you

and your team?

FM: The dynamic tension

that exists between my

team and me is a good thing

because the guys force me

to keep my bottom-up eyes

open, and I force them to

keep their top-down eyes

open. So I like that tension.

We all get along. This is a

group that appreciates my

perspective, and I appreciate

theirs. We have an open

forum – everybody can say

what’s on his mind.

Ultimately, I make the final

decision, but I respect these

guys, so I listen to them.

G&D: You said in your

book, A Decade of Delusions,

that you attempt to

continually understand the

psychology of the

marketplace to gain a

competitive edge. What is the genesis of your interest

in, and commitment to,

understanding the

psychology of groups?

I think this is something that

I hope you will put in your

mental hard drive, because

it’s been a great asset to me

over the years. Again, I live

in Elkhart, IN. It can be

very intimidating reading the

guys interviewed in Graham

& Doddsville, or, if I’m

inclined – which I’m typically

not – to watch CNBC and

the talking heads. There are

some guys in this industry

who are really smart. So I

may ask myself, what edge

do I possibly have with this

crowd?


Pictured: Bruce Greenwald

and David Einhorn at

CSIMA Conference in Feb-

ruary 2012.


Frank Martin

there’s a chance the future

will prove that I’m wrong

about a decision that I’m

considering, whether I’m

wrong because of biases or

I’m wrong because I

incorrectly assessed the

situation, if the downside is

permanent loss of capital, I

can’t go forward with that decision. If the downside is

the loss of an opportunity,

then I’m okay. By playing

defense like I’m playing right

now, the worst that will

happen to those for whom

I’m a fiduciary, if you believe

that cash is a good hedge

against deflation and a

respectable hedge against

inflation, and offers huge

optionality, is that I’m going

to let an opportunity slip by.

The beauty in this business

is that there are just hordes

of future opportunities

waiting and some of them

may be huge if you’re

patient. And I think Ben

Franklin summed it up well:

“He who has patience can

have what he will.”

For those who are long with

the throng, they’re going to

have to explain, if I’m right,

why they’re down, say, 50%.

I’ve never been in that

position; our clients have

never suffered a bear

market. In bull markets,

you underperform. Being

down under 7% in 2008 and

being up so nicely in 2009

probably put us in the top

5% of our class. But we

trailed pretty significantly

from 2003 to 2007. And

I’m trailing now again. So

I’m a classic ‘win by not

losing’ guy, at least for the

time being – at least in this

high-tail risk, overvalued

market. But I will welcome

when “this too will pass”

because this is no way to

live. I’d rather be totally

focused on individual

companies, fully invested,

and sticking the ones I really

like in a lockbox – like

Gentex – not even thinking about it for five or ten

years.

G&D: Your firm’s annual

report shows that since

2000, you’ve never been


G&D: Even Kahneman

admits that knowing about

the failings of human

psychology and decision-

making doesn’t mean you

won’t still fall prey to them.

Are there specific steps in

your investment process

that ensure you won’t fall

prey to these biases and

heuristics?

FM: That’s a problem

everybody has to

acknowledge that they have.

It’s painful to read a book

like his because you wonder

just how much of your

subconscious biases are

ruling your decision-making.

I try to benchmark my

thinking, and thus try to

override my biases, by

frequently looking at a host

of charts I’d made using Bob

Shiller’s 10-year moving

average data. I’m aware

that biases exist. What I

don’t know is to what extent they invade my

otherwise rational mind.

Clearly they do but I am

utterly uncertain as to how

much. I find some solace in

the Bertrand Russell quote:

“The trouble with the world

is that the stupid are

cocksure and the intelligent

are full of doubt.”

I agree with Nassim Taleb –

whose work I find incredibly

stimulating although he can

be an offensive writer – that

everything has to go

through the Pascal’s Wager

filter (he couldn’t even

resist taking issue with the

great French

mathematician’s and

probability theorist’s use of

the spiritual metaphor!). If


“If there’s a

chance the future

will prove that I’m

wrong about a

decision that I’m

considering,

whether I’m wrong

because of biases

or I’m wrong

because I

incorrectly

assessed the

situation, if the

downside is

permanent loss of

capital, I can’t go

forward with that

decision.”

Frank Martin

nets around 5.6%. That’s

just awful. So I thought,

let’s come out with a pricing

structure that I would want

when my estate comes to

be managed by my firm after

my death. So I came up

with a 90 basis points

maintenance fee for most

accounts, or – ‘or’ is the

critical word – 10% of the

gains above a high water

mark. Granted, this is

Elkhart, but this money

management business, if you

actually make money for

clients, is nicely profitable,

even at 90 basis points or

10% of gains above a high

water mark.

If you look at this in the

context of the grand sweep

of history, we are living in a

most unusual time that is

surely getting long in the

tooth. In finance everything

is cyclical whereas in, say,

technology, today’s ideas

are built on the shoulders of

yesterday’s. Think iPod,

iPhone, and iPad. You can

make incredible fortunes in

this business, and you don’t

have to overcharge to do it.

You get to build equity,

which means you never

have to worry about your

finances, unless you’re a bad

investor. If anything, our

industry has become an

embarrassment of riches. In

the aggregate, after fees we

are a negative value-added

proposition.

People say to me at parties,

“How come you’re not

charging regular hedge fund

fees?” (People mistake us

for a hedge fund because of

our investment style.) “Isn’t

your hedge fund valuable

enough?” And I reply, “I

don’t know. Look at our

track record for yourself.”

And they say, “Well, your

track record is pretty

good.” And I say, “Why

should I charge 2 and 20?”

And they say, “Well, if you

don’t, you give the

impression that your service

isn’t as valuable.” The “you

pay for what you get” belief

is so well entrenched – with

substantial justification in

most cases – that the

weaker players among the

hedge funds have been able

to thrive unexposed under

that perceptual umbrella. I

suspect that 2 and 20 will

have changed dramatically

by 2020 because it simply

cannot survive forever in a

low-return environment.

Maybe we’ll be seen as

leading the charge.

Admittedly, I think it’s hard

for a value investor to

understand the appeal of

Veblen goods – like the high

-end German cars or Rolex

watches – or even most

hedge funds.

G&D: What was the

impetus for launching your

first mutual fund in May of

2012?

FM: We never had a

marketing person until two

years ago. We brought on a

fellow who I believe is a

great marketing thinker and strategist. He asked me

when he came aboard,

‘Why don’t you have a

product for the retail

investor?’


more than 70% invested.

Were there times in the

late 1980s or during the

1990s where you were fully

invested?

FM: I started managing

money for others in 1987

and for myself for many

years before. I was always

100% invested. That could

be long tax-exempt bonds

at 14%. It might have been

owning a bank in the early

1980s. In fact, the 1980s

were a most atypical period

for me. I actually borrowed

money for a while. I’m a

guy who doesn’t like to use

leverage. I haven’t

borrowed money for the

last 30 years of my life for

anything – I pay cash for

everything, because I think if

an investment doesn’t work

without leverage, it’s not an

investment you should do.

But the 1980s were a time

where I had many more ideas than I had money. I

can envision a period in the

future where this could

happen again. It’s easy to

imagine a number of

scenarios that could cause

prices to sell as dramatically

below what they’re worth

as they have been selling

dramatically above what

they’re worth.

G&D: Your separately

managed accounts don't

have a traditional fee

structure. Can you talk

about your fee structure

and why you feel it’s a

better alternative to the

traditional 2 and 20?

FM: Obviously a 10% gross

return with a 2 and 20 fee



Frank Martin

If you can reach those kinds

of people, you’ll have the

kind of investors you want

and deserve. We take the

relatively unusual tact of

posting commentaries to

the fund’s website [Martin

Focused Value Fund] to

keep investors regularly

apprised of our thinking.

The most recent was “Why

Would an Enterprising

Investor Hold Cash Today?”

With our fund, like our

separately managed

accounts, we depart from

the mainstream: we control

the critical asset allocation

decision like the FPA funds

do. Done right, it has a

very salutary effect on dollar

-weighted returns. Most

investors chase

performance while we are

looking for value. I doubt

that we will ever have a

problem of too much

money coming in over the

transom. But still, biggest is

not always best.

If I can read the tea leaves

and we do go through this

cathartic process, it’s

probably going to be like

post-1974. Buffett knocked

the ball out of the park from

1974 to the early 1980s in a

bumpy, flattish market. The

public was exiting the

markets, particularly

through funds. But what he

found was lots of individual

values. If I could paint a

picture of the future, I’d say it’d be something like that,

or maybe something like

Japan. There have been

great opportunities in Japan.

But ever since the Nikkei

225 began its long

meltdown from 39,000 in

1989, ultimately getting as

low as 7500 and currently

trading around 10,800, it’s

been a trader’s or

contrarian investor’s

market. I hope that we

don’t go into a Japan-style,

lethargic period, but unlike

the post-2009 episode, I

don’t think we’re going to

go back to the races

following the next down leg.

If it’s more like the post-‘74

experience in the U.S.,

sentiment will be negative

and prices will remain cheap

and investors will stay risk-

averse for a much longer

time. Stocks will be

unpopular and the whole

process will be anything but

glamorous. In that

environment, I think the

fund could do well because

then we could strictly focus

on stock-picking and grow

slowly, while attracting the

kind of clients who just

might stay the course. I

openly admit that trying to

find permanent capital in the

mutual fund space

admittedly may be insanity

by another name. I think

Chuck Royce talked about

that in his Graham &

Doddsville interview (Fall

2012 issue).

G&D: Can you walk us

through your process for

finding new ideas?

FM: Obviously one thing

we don’t have, which Warren Buffett and Seth

Klarman do have, is

incredible sourcing

opportunities for

investment ideas. We have

about 40 names that we’ve


Sometimes you need a

catalyst to overcome inertia.

First of all, it takes you

about a year, if you are

methodical, to get the

concept from inception to

market. Then we went out

and talked to some people

that we like as long-term

investors. We said to them,

“Are there buyers for a fund

that is basically a call option

on financial assets becoming

more rationally priced,

maybe even cheap?” Bob

Rodriguez, who’s been as

risk-averse as I have, says

that in expensive markets,

he'd try to get people to

buy his fund. He'd say,

“We’ve got a lot of dry

powder take advantage of

opportunities as they

appear” (Of course they

think 30% cash is

extravagant. I think 30%

cash is straddling the

fence!). What Rodriguez

found is that they’ll say, “I don’t want to put my

money with you now, and

pay fees, because you’re not

earning anything. Call me

when things get cheap.”

But, most investors are

afraid to buy when

everything’s cheap. Even if

they know things are cheap,

they worry that they will

become cheaper and they

find it difficult to pull the

trigger. So the trick for us

is to see if we can get

people into the fund

without any assurance other

than that we have the

courage of their convictions

– when prices were higher!

We’ve been good at

stepping up when times are

tough and stocks are cheap.


Pictured: Bill Ackman of Per-

shing Square Capital Manage-

ment at Pershing Square Chal-

lenge in April 2012.

Frank Martin

G&D: What advice do you

have for students interested

in the investment

management industry?

FM: As soon as you can

disabuse yourself of the

importance of money, it will

help you immensely. All the

stuff that’s important in life,

you get for free. All the

stuff that’s unimportant, you

buy with money. When I

first started, I said to myself,

‘Boy, as soon as I make a

million dollars, I will be

secure.’ Now that shows

you how misguided I was.

But as a starving student,

you’re really low on

Maslow’s hierarchy. It’s not

unnatural to think, ‘money

will fix my problems.’ But if

you can disabuse the notion

that money is a measure of

success, it will really help

you.

Money is very corruptive.

Obviously it’s not been the

case with Buffett. You’ll

notice the way he lives.

People don’t talk about this

very often, but it’s clear in

John Templeton and

certainly in Buffett, that the

great value investors have a

lifestyle that’s earmarked by

frugality. There is no doubt

in my mind that Buffett

discovered early on that

redundant personal assets

are really liabilities in

disguise – that you can easily

lose your personal freedom by becoming slave to your

possessions. In fact, I’ve

never really understood

how a guy can claim to be a

fully committed value

investor and live big. You

talk about going to see

managements and looking

for little clues about

whether their behaviors

reconcile with their talk.

When I see a value investor

who lives really big, it

strikes me as a

contradiction in terms. I

know there are many

exceptions and there are

dangers in stereotyping –

but when you see such

lifestyles, it makes you want

to dig a little deeper.

G&D: It’s obvious from

this interview that you are a

voracious reader. Keeping

the list pretty short, what

books would you

recommend that students

read?

Toward disabusing money

as a measure of success, I

recommend two books.

One is Viktor Frankl’s Man’s

Search for Meaning. In that

book, he says that success,

money, and all the

accouterments of the so-

called “good life” should

never be sought for their

own sake, but should be the

unintended side effect of

devoting yourself to a cause

greater than yourself, or

loving a person more than

you love yourself. If you

can identify what you’re

doing as a cause, and it

happens to be remunerative,

it can be a good thing. One

of the things I decided when

I made my career choice is that if I’m going to be good

at what I did, I’d like to be

paid for it. This profession

does that. It’s what you do

with your largess that

defines you. “The measure


identified as businesses we’d

like to own at a price. The

cost structure of building

and maintaining an inventory

of “ideas” is quite different

from manufacturing. In our

fixed-cost business, we

analysts think of ourselves

as Santa’s elves, working day

in and day out to build

inventory for Christmas.

Our job is to build an

inventory of investable

ideas, so that when prices

come to us, we’ll get to pick

maybe 15 or 20 names.

We’d like to get it up to

about 50, and then we’d like

to do what Gerald Loeb,

from E.F. Hutton,

recommended years ago –

every time you add one, you

take one away.

We obviously won’t know

in advance which

companies, out of these 50,

we’ll buy, but we’ll follow

them closely and add them individually to the portfolio

when they get down to a

price that is likely to

produce an expected

return of, say, at least 15%,

properly risk-adjusted. So it

won’t be top-down at all.

It’ll just be when individual

names like Gentex fall to a

price range where I can say,

this thing’s going to double

in five years or less. We’ll

default into being fully

invested. Obviously,

exogenous forces like bear

markets produce a plethora

of buying opportunities.

One must be more

circumspect when the

precipitating forces that lead

to lower prices are

endogenous.


“People don’t talk

about this very of-

ten, but it’s clear in

John Templeton

and certainly in

Buffett, that the

great value inves-

tors have a lifestyle

that’s earmarked by

frugality. … In fact,

I’ve never really un-

derstood how a guy

can claim to be a

fully committed

value investor and

live big.”


Frank Martin

Adam Smith is famous for

Wealth of Nations. But my

favorite book of Adam

Smith’s is The Theory of

Moral Sentiments. Smith

basically says, if you take

care of your customers’

interest, you’ll take care of

your own. So if you sell the

best good and if you meet

the customers’ needs better

than your competitors,

you’ll always do well. The

theme of Smith’s second

book explains why the

system broke down in the

last 15 years. The Theory of

Moral Sentiments spoke about the importance of

ethical behavior throughout

the system. So when

people – and this is Charlie

Munger’s big criticism which

he calls “moral drift” –

started cutting corners and

exploiting the asymmetry of

information between agent

and principal in increasingly

complex systems, capitalism

broke down. It’s because

everybody forgot the

second of Adam Smith’s

two great books. It’s a

great system, but only if the

players live by the Golden

Rule.

Lastly, some of the most

important of life’s lessons

are not taught in books. By

all means, find mentors who

you think are really worthy

of respect, people who have

lived their lives in ways that

you admire. You can’t

imitate Buffett, but you can

emulate him. I have a

mentor wall that is the first

thing you see in my small

office. By identifying men

who you really admire, you

can shortcut your learning

curve tremendously. You

learn ethics by example.

Jack Bogle and Warren

Buffett, in terms of shaping

my values, have really had a

huge impact. And I

probably have another 10 or

15 people on the list of

people to whom I am in

debt in perpetuity. If you

want to, you can make all

the mistakes by trying to

learn everything yourself, or

you can sit at the feet of the

masters, which I have

chosen to do, and shortcut

that.

G&D: Mr. Martin, it’s been

a pleasure speaking with

you.

of a man is not what he

gets, but what he gives.”

I’d also have people pick up

Kahlil Gibran’s The Prophet.

He writes about work, and

he writes about giving.

Those are two chapters that

I would highly recommend

to young people. I think

that will help shape who you

become.

I’m 70 years old and I’m in a

wheelchair. Even though I

no longer play golf, I’m like

the golfer who shoots

(works) his age [laughs]. It

isn’t work at all. I love it. I

don’t want to acquire

knowledge for knowledge

sake, rather for wisdom’s

sake. When I read that

Todd Combs researches an

idea for 500 hours before

he buys it, that’s kind of

impressive. That’s what all

of our analysts and I should

aspire to. If you’ve read Outliers, you’ll understand

that you’ve got to do the

10,000 hours. There are no

shortcuts. Too much IQ

can actually be an

impediment. When I read

the stories of the great

achievers in our industry,

most of them appeared to

have ample intelligence.

What seems to differentiate

them is that they appear to

have overcome the

limitation embedded in the

idea that “because I’m so

smart I don’t have to work

very hard.”

Don’t limit yourself to just

reading business and

economics. Read

philosophy and read the

great economic thinkers.


“If you want to,

you can make all

the mistakes by try-

ing to learn every-

thing yourself, or

you can sit at the

feet of the masters,

which I have chosen

to do, and shortcut

that.”

Russell Glass

construction figuring they

do a great deal of future

traffic pattern analysis and

demographic research to

determine attractive

locations. A few years later,

in high school, I used to

read Value Line investment

research reports and was

fortunate to get a summer

internship at LF Rothschild

Unterberg Towbin where I

worked in the risk arbitrage

department. It was a great

learning experience to

analyze companies involved

in M&A activity. I then went

to Princeton and majored in

economics. After

graduation, I started my

career at Kidder Peabody &

Co., where I worked in

corporate finance advising

companies on their defense

of hostile takeovers, which

put me at the forefront of

the 1980s hostile takeover

wave. Afterwards, I decided

to go to Stanford Business

School where I had a

roommate who happened

to be the nephew of Alex

Spanos, the owner of the

NFL’s San Diego Chargers

and founder of the A.G.

Spanos Companies, one of

the top real estate

developers in the country.

Eventually, I started working

as a financial advisor for the

privately held Spanos

organization on a part-time

basis while in graduate

school. My schedule at

Stanford was unique in that I would go to class in the

mornings, then frequently

take the Spanos corporate

jet to attend business

meetings during the day, and

later fly back in time to

attend class in the

afternoon.

After graduation from

Stanford Business School, I

set up Premier Partners, a

merchant bank in Dallas

with a close friend and

classmate of mine from

Princeton. Our first

transaction was advising

Jerry Jones on the $140

million acquisition of the

NFL Dallas Cowboys when I

was 26 years old. Although

many who did not know

him at the time thought

Jerry may have overpaid

because the highest price

for an NFL franchise until

then was only $100 million,

the investment has yielded

greater than an estimated

20x return, or $3.5 billion in

value, as the team is

currently appraised for

approximately $2 billion and

has probably generated

cumulative operating profits

in excess of $1.5 billion.

The Cowboys went 1-15

during Jerry’s first year of

owning the team but ended

up winning the Super Bowl a

few years later. The fact

that Jerry was able to sell

luxury suites in a very weak

economy at the time and

turn around an

uncompetitive team early in

his ownership tenure

demonstrates what a

consummate marketing

expert and extraordinary

entrepreneur he is.

G&D: How did your

career progress from

advisory into investing?

RG: My focus has always

been on investing in


Glass is co-owner of the

New York Mets and is a

director of the San Diego

Chargers. He also advised

Jerry Jones on the $140

million acquisition of the

Dallas Cowboys when he

was 26 years old. Mr. Glass

earned his B.A. in

economics from Princeton

University and his MBA

from Stanford Business

School.

G&D: What was your

introduction to investing?

RG: Growing up, my main

interests were investing and

sports, though I found I was

more successful with

investing. I have been

fortunate to pursue both

these interests throughout

my career. On the

investment side I have

served as the President of

Icahn Associates, the

investment firm of Carl

Icahn, and later as the founder of RDG Capital

Management. On the

sports side I recently

became a co-owner of the

New York Mets and, for a

number of years, I have also

been a director of the

Spanos-family-owned San

Diego Chargers. My

interest in investing started

at an early age. I made my

first investment at age 13

when I bought some

California real estate in

northern Los Angeles

County prior to the

construction of a new

highway that would reduce

commute time from the

property to downtown by

half. I purposely selected

land close to a new

McDonald’s that was under


“My schedule at

Stanford was

unique in that I

would go to class in

the mornings, then

frequently take the

Spanos corporate

jet to attend

business meetings

during the day, and

later fly back in

time to attend class

in the afternoon.”

Russell Glass


Russell Glass

as well as investor Carl

Icahn. After some time

though, I realized that being

a principal had a number of

advantages over being a

research analyst.

I decided to partner with a

group of former executives

and associates of T. Boone

Pickens forming Relational

Investors, an activist fund

based in California. The

idea of the fund was to use

corporate governance as a

means to hold management

accountable to

shareholders. I saw the

efficacy of being a proactive

investor in companies years

earlier, after seeing Boone

Pickens’ success with Gulf

Oil, which when he invested

in it, was trading at a steep

discount to the intrinsic

value of its reserves because

it was so poorly managed.

After a couple of years at

Relational, Carl Icahn

recruited me to become

President of Icahn

Associates. Carl was a

great mentor. He is a self-

made professional with

great intelligence and

strategic acumen – he went

to Princeton from a public

high school that had

probably never sent a

student to Princeton before.

Carl was one of the first and

most prominent investors

who believed in taking a

proactive approach to

investing in public companies. When I joined

his firm he had already

established himself as a

legendary investor.

G&D: How does Carl

compare to other investors

whom you’ve worked with

or have come in contact

with throughout your

career?

RG: In my opinion, Carl

has been the pioneer of

catalyst-driven, activist

investing. He is both a pure

value investor and tactician

who has produced

investment success with a

multitude of companies,

both on the long and short

sides. Carl’s returns have

been excellent and he is an

impressive short seller,

which most people don’t

know or pay attention to.

His investments have

compelling risk-adjusted

return profiles. When you

look at other investors or

hedge funds, you cannot just

look at the headline return.

You need to know how

much leverage was used and

what other types of risks

were taken to generate

those returns. Carl’s

portfolios are prudently

hedged, so I would say that

his risk-adjusted returns are

even more impressive than

most realize.


your current firm, RDG

Capital?

RG: At RDG, I have

essentially replicated the

staffing and structure at

Icahn Associates. We have

four investment professionals, all of whom

have M&A backgrounds.

Our investment style is

private equity oriented – we

employ a hybrid private

equity / public investment


companies that are

undervalued – I’m a value

investor. After advising

Jerry Jones on the Dallas

Cowboys purchase, I set up

an independent investment

research firm called Premier

Investment Research and

served as an investment

advisor to a select group of

investors including the Hunt

family, owner of the NFL

Kansas City Chiefs, led by

Lamar Hunt, who was both

a sports visionary and

successful businessman.

Our investment research

firm provided investors with

in-depth, fundamental, 100-

page research reports. We

were hired on an annual

retainer basis – so it was

truly an independent

research service with no

conflicts of interests. We

were not paid on our ability

to trade or set up

management meetings, but

rather on our ability to help our clients find profitable

ideas. Back then, 99% of

Wall Street research had a

‘Buy’ recommendation, but

our research was 1/3 ‘Buy’,

1/3 ‘Sell’, and 1/3 ‘Fair

Value’.

We took the approach of

looking at public companies

from the perspective of a

private equity owner. Our

research consisted of

thorough due diligence as

opposed to just predicting

next quarter’s earnings.

This thoroughness caught

the attention of a number of

mutual funds, hedge funds,

and investment managers

such as Fidelity Investments,

Wellington Management,

and Neuberger & Berman,


“The idea of the

fund was to use

corporate

governance as a

means to hold

management

accountable to

shareholders. I saw

the efficacy of

being a proactive

investor in

companies years

earlier, after seeing

Boone Pickens’

success with Gulf

Oil, which when he

invested in it, was

trading at a steep

discount to the

intrinsic value of its

reserves because it

was so poorly

managed.”

Russell Glass

if we believe an opportunity

is compelling, not just

because we have to put

money to work. As a result

our investment process

yields a high rate of

profitable investments

because we have such a high

threshold for value – we

typically require at least a

50% “margin of safety” as

Seth Klarman from Baupost

would say.

G&D: Can you give us a

little detail on your research

process?

RG: We first conduct a

statistical valuation screen

to generate ideas, and if

they pass our screen, we

perform a more detailed

quantitative assessment and

analyze companies on a

qualitative basis. While our

systematic screen finds public companies that trade

at a significant discount to

peers, we also look at things

others often do not focus

on or issues for which the

market unjustly penalizes

companies, such as pre-

opening expenses, growth-

oriented R&D and capital

expenditures, or other

costs associated with

investing for the future. If

you find cheap companies

that are unfairly penalized

for making long-term

investments in the business,

those investments can

become very productive and

yield significant returns for

the business and its

investors. We also favor

companies which trade at

low valuations relative to

their

sustainable

free cash

flow that

have

operating

margin

improvement

potential and

which often

have a sum

of the parts

value in

excess of

their trading

price.

Once having

identified interesting

undervalued companies, we

then conduct extensive due

diligence with management,

industry analysts, customers,

competitors, bankers, and

often private equity firms

who have relevant sector

expertise. I have also been

on the board of several

companies in an array of industries, including real

estate, energy, biotech,

manufacturing, and business

services. These

directorships give our team

insights into many types of


strategy. We look for

undervalued public

companies that can benefit

from a catalyst to both

enhance and unlock value.

We focus on U.S. equities,

consider ourselves to be

industry agnostic, and invest

across the market

capitalization spectrum,

although most of our

historical investments have

generally been in small and

midsize companies. Among

the catalyst events we

generally focus on are

private equity

and strategic

buyouts,

corporate

spinoffs and

divestitures,

monetization

transactions of

non-core

assets, share

buybacks,

special

dividend distributions

and other

recapitalization events, and

improvements in operating

management and corporate

governance.

Historically we have

structured special purpose

investment partnerships

with co-investors who we

believe bring strategic value

or industry experience to

each investment

opportunity. I have always

believed some of the best

investment decisions are

those you choose not to

make. Our special

situations investment

approach allows us to invest


“I have always

believed some of

the best investment

decisions are those

you choose not to

make. Our special

situations

investment

approach allows us

to invest if we

believe an

opportunity is

compelling, not just

because we have to

put money to

work.”

RDG Capital team


Russell Glass

million, despite the fact that

the company had only

recently invested $150

million in cumulative capital

expenditures over the prior

few years. The market was

discounting the recent

capital improvements by

50% and assigning zero value

to the existing restaurant

chain generating $25 million

in recession-level EBITDA

which you were essentially

getting for free.

At the time, the company

was trading at less than 3x

EBITDA and, moreover,

owned about $50 million

worth of real estate

underlying several of its

restaurant locations which

could be monetized via a

sale/leaseback transaction.

If you took the near $75

million enterprise value and

subtracted the approximate

$50 million in real estate

value, the company was

really trading at just 1x

EBITDA adjusted for the

modest incremental rent

expense. Furthermore, at

the time of our initial

investment, the economy

was just starting to come

out of the recession, and we

believed that the company

could increase EBITDA

from $25 million to $40+

million just based on a

recovery in same store sales

growth and without any

operational improvements.

Yet, we were also able to identify a number of

operational improvements

that could be made,

including centralization of

purchasing (many of the

restaurants at the time had

been buying supplies

independently), improving

staff scheduling, increasing

higher-margin beverage

revenue mix, and licensing

the Benihana brand to

selected grocery products.

Finally, we were also

attracted to the fact that in

addition to owning its

flagship restaurant chain,

Benihana also owned two

other restaurant concepts,

New York-based Haru and

Mid-Atlantic-based RA

Sushi. These restaurant

chain subsidiaries separately

were worth nearly the

entire market value of the

parent company.

We decided to team up

with a restaurant-focused

private equity firm and

made a buyout offer to the

company. Though our offer

was rejected, the company

subsequently hired Jefferies

to explore strategic

alternatives and eventually

sold itself to Angelo

Gordon. The stock went

from $4 to $16 per share in

less than two and a half

years.

As industry-agnostic

investors, we look for public

companies that would be

better off being private

entities. If you look at a

typical industry-focused

fund, the sector that it

focuses on would likely be

compelling as an

undervalued opportunity only 5% of the time, and it

would be reasonably valued

or overvalued the other

95% of the time. This is the

nature of a reasonably

efficient capital market –


businesses and provide

valuable operating executive

relationships. We have a

great pool of industry

contacts that we can call on

when we need to do a deep

dive to learn about an

investment opportunity. If

we still find the opportunity

attractive after such an

evaluation process, we then

consider what catalyst

events may enhance and

unlock shareholder value.

Finally, we consider the

corporate governance

structure and shareholder

composition of a company

to determine the feasibility

of implementing the desired

catalyst initiatives.

Ultimately, we seek to

invest in those companies

which meet all our

investment criteria. It is a

very time- and labor-

intensive process, as we

want to understand the

business and not just the security. That process

usually takes about three to

six months before we make

each investment. By

maintaining these

investment disciplines and

acting like private equity

investors in publicly traded

companies, we have

historically generated

unlevered IRR in excess of

30%.

G&D: Can you provide an

example of this strategy as it

applied to a past

investment?

RG: A couple of years ago,

we invested in Benihana, the

Japanese steak house chain.

At the time, the enterprise

value was less than $75


“As industry-

agnostic investors,

we look for public

companies that

would be better off

being private

entities. If you look

at a typical industry

-focused fund, the

sector that it

focuses on would

likely be compelling

as an undervalued

opportunity only

5% of the time, and

it would be

reasonably valued

or overvalued the

other 95% of the

time.”

Russell Glass

professionals have M&A

backgrounds, which we find

helpful to navigate these

corporate governance

matters.


recent investment?

RG: Several months ago, we became involved with an

enterprise software

company called JDA

Software. JDA is primarily

known as a best-in-class

supply chain management

software vendor for the

retail and manufacturing

industries. For large

retailers and manufacturers,

this is mission critical

software – approximately

75% of the top retailers and

manufacturers use JDA’s

software. The supply chain

management software

industry has been

undergoing significant

consolidation.

When we started looking at

the company, we were able

to identify a high quality

company trading at a low

valuation relative to its

sustainable free cash flow

with significant costs that

could be cut out by a

strategic acquirer. Trading

around $27 per share, the

company had an

approximate $1 billion

enterprise value and,

generating nearly $200

million in EBITDA, was

trading at only 5x EBITDA,

or an approximate 20% free

cash flow yield given the low

capital-intensive nature of

the business, with

substantial recurring

revenue from long-term

software maintenance

contracts. Based on our

analysis, we believed a

strategic buyer could

extract as much as $125

million in synergies so, in

reality, the company could

generate more than $300

million in adjusted EBITDA,

implying an approximate 3x pro forma EBITDA multiple,

an especially attractive

discount to the 10-12x

average EBITDA multiple of

its enterprise software

industry peers.


much of what is out there is

fairly priced at any given

point in time. We try to

focus on the 5% of

companies that are valuation

outliers, regardless of the

industries that they’re in,

and because of this, we will

typically only invest in half a

dozen to a dozen companies

on an annual basis.

G&D: What is your

targeted time horizon for a

typical investment?

RG: We’d ideally like to

see value created within a

year’s time, if not sooner,

but we are not short-term

opportunists. As

arbitrageurs of value we are

content to invest in longer-

term opportunities. Our

investments have generally

ranged from six months to

two years. The longer

you’re in an investment, the

longer you’re subject to exogenous risks. If you can

influence change sooner, it

increases your IRR and

reduces macroeconomic

risk. We aim to generate

the highest return with the

least amount of risk, so the

faster we can help push

along the value-unlocking

moves that need to be

made, the better.

We also view a company’s

annual meeting as a way to

enact change and gain

support from other

shareholders. Every public

company is required to hold

an annual meeting, and

some companies allow for

the calling of a special

meeting. As I mentioned

earlier, all of our investment


“We’d ideally like

to see value created

within a year’s time,

if not sooner, but

we are not short-

term opportunists.

As arbitrageurs of

value we are

content to invest in

longer-term

opportunities.”

Pictured: Tom Russo

speaks at the Omaha Din-

ner in May 2012.


Russell Glass

recently completed

acquisition and the pending

introduction of new

products. JDA also had an

M&A value according to our

analysis that indicated a

private equity or strategic

acquirer could justify paying

$45+ per share or a 50%+

premium and still expect to

generate an attractive 25%+

equity IRR and an active

shareholder base with

customary corporate

governance policies. In fact,

we believed the private

market value was double

the public market value.

We liked the investment

because there were multiple

ways to win, either through

an accretive share buyback

or a sale of the company at

a substantial premium. In

the end, the company

recently received a $45 per

share buyout offer from Red

Prairie, an enterprise

software company owned

by private equity firm New

Mountain Capital. It was a

good outcome for

management, private equity

investors, and shareholders.

G&D: In a recent guest

lecture at Columbia

Business School you

mentioned that you believe

there will be a tsunami of

buyouts in the next couple

of years. Could you expand

on that?

RG: We estimate there is

approximately $150 billion

in private equity capital that

was raised a few years ago

in vintage 2007-2008 buyout

funds that has yet to be

deployed and needs to be

spent in the next 24 months

before LP capital

commitments expire.

Private equity firms are

eager to put this capital to

work. We figure altogether

there is $300+ billion in

private equity “dry powder”

plus $750 billion in readily

available low-interest debt

financing in a robust credit

market (in which leveraged

buyout debt/EBITDA

multiples have increased to

near historic levels); this

translates into $1+ trillion in

private equity-sponsored

acquisitions in the next 24-

36 months. Additionally,

there is $1.7+ trillion in

cash on the balance sheets

of non-financial

corporations, nearly one

third of which is higher than

amounts typically held under

normal economic

conditions. We believe a

reasonable portion of this

capital (together with new

public equity issuance and

additional debt financing)

will be directed toward

public company M&A

activity.

Our thesis is that in the last

few years, most companies

have grown earnings by

cutting costs. By now, most

companies cannot cut costs

much more because there is

no room. Economic growth

is going to be slow for the

foreseeable future, which

means that for most companies, top-line revenue

growth will be sluggish.

Therefore, in order for

companies to grow bottom-

line earnings there is strong

motivation to acquire


At the time, the company

was under investigation for

accounting irregularities by

the Securities and Exchange

Commission. We looked

into the accounting issue

and determined that it was

not fraudulent in nature, but

rather a minor issue

regarding the historical

timing of revenue

recognition. JDA was also

in the process of completing

the integration of an

acquisition and preparing to

introduce a promising new

multi-channel software

product, so we expected

better results going

forward.

Based on the steady nature

of its business – high-margin

long-term contracts, sticky

customer relationships, and

low churn – we thought the

company could easily do a

highly accretive leveraged

recapitalization share buyback which would result

in stock appreciation from

$27 to $40 per share. One

of the two largest

shareholders had already

achieved board

representation and was

advocating for a sale of the

company. The company’s

valuation metrics and

fundamentals were

compelling. It had a low EV/

EBITDA multiple on both an

absolute and relative basis

compared to its peers, was

trading at a 20% free cash

flow yield, was growing

revenue and earnings at high

single digits on an organic

basis, and had operating

margin improvement in

process from the cost

savings implemented in a


“We figure

altogether there is

$300+ billion in

private equity “dry

powder” plus $750

billion in readily

available low-

interest debt

financing in a

robust credit

market (in which

leveraged buyout

debt/EBITDA

multiples have

increased to near

historic levels); this

translates into $1+

trillion in private

equity-sponsored

acquisitions in the

next 24-36

months.”

Russell Glass

RG: Working with Carl

(Icahn) helped me see the

merits of being a proactive

investor in companies. Just

as Steve Schwarzman and

Henry Kravis find attractive

businesses and enhance

those businesses, we believe

professional public market

shareholders can do the

same. It’s important to look

at companies through the

lens of a private equity

investor. We like a hybrid

approach – being a public

shareholder but thinking and

acting like a private equity

fractional business owner.

Although we lack the

absolute control of a private

equity owner, in cases

where we garner the

support of a majority of

shareholders, we become

the informal voice of the

majority and thereby have

influence on management.

In the past we have hosted

informal shareholder forums

to discuss the management

and future direction of

companies in which we are

a stakeholder. The benefit

of being a public investor is

that you can typically

acquire equity at a

significant discount to its

intrinsic private market

value (rather than a buyout

premium), employ no

leverage (rather than 4x or

often greater debt/EBITDA

in an LBO), and still have an

element of constructive

influence on the company.

There’s been a positive

change towards shareholder

activism in the past 10

years. The rise of proxy

advisory firms has provided

a level playing field. After

recognizing years of

corporate mismanagement

and malfeasance,

institutional investors have become justifiably more

active and now have a

greater willingness to

support dissident

shareholder initiatives.

Unlike in the past when


industry competitors and

eliminate duplicative costs.

This scenario should result

in an increase in both

friendly and hostile M&A

activity in the next few

years. In fact, this

expectation is supported by

a relatively recent Ernst &

Young survey which

indicated that 36% of U.S.

corporations intend to

engage in M&A activity

within the next year or so.

G&D: It sounds like some

of those supportive

dynamics have been in place

for a while. Why do you

think the buyout activity

hasn’t ramped up this year?

RG: The election certainly

played a part – corporate

executives don’t like to

make important M&A

decisions in an uncertain

environment. They want to

know what the tax, healthcare, and regulatory

environment is going to

look like. With the election

over, there is more clarity.

Companies have reached

the end of their cost-cutting

ability, as well. To put this

in a sports analogy, we

believe that we’re in the 7th

or 8th inning of companies

reducing internal costs and

will now begin to see a shift

to acquiring businesses.

G&D: Do you think activist

investors are still viewed

with a stigma? It seems like

it is now more socially

acceptable, if you will, to

engage management and

advocate for change than it

was 10 or 15 years ago.


“It’s important to look

at companies through

the lens of a private

equity investor. We like

a hybrid approach –

being a public

shareholder but

thinking and acting like

a private equity

fractional business

owner. Although we

lack the absolute

control of a private

equity owner, in cases

where we garner the

support of a majority of

shareholders, we

become the informal

voice of the majority

and thereby have

influence on

management.”


Russell Glass

management does not have

their personal interests

properly aligned to

maximize shareholder value.

In these cases, we organize

shareholder forums, engage

in proxy contests, and

exercise other corporate

governance measures to

hold management

accountable to serve the

best interest of

shareholders.

G&D: You’ve done

academic research around

activist investing and how

once an activist becomes

involved, a company’s stock

price outperforms the

market. Can you talk a little

about your research?

RG: As an undergraduate

majoring in economics at

Princeton I wrote an

academic research report

on the efficiency of capital

markets and the economic

benefits of shareholder

activism and hostile

takeovers. Since then, there

have been numerous

academic studies highlighting

the efficacy of shareholder

activism on investor returns.

In a study conducted by

researchers at Wharton and

Columbia Business School,

companies which had been

the subject of 13D filings

indicating the presence of an

activist shareholder

generally outperformed the

S&P 500 by approximately 5%-7% per annum.

G&D: Do you feel that the

activist investor field is

getting crowded? Are there

still the same opportunities

for you that were available

10-15 years ago?

RG: While the number of

activists has grown modestly

in recent years I believe the

opportunity set has grown

more and that we are still at

the early stage of public

shareholders taking more

initiative in the governance

of the companies they own.


few mistakes you've made in

your career?

I should have bought more

land in southern California

when I was 13 years old.

G&D: What’s the best

advice you’ve ever received?

RG: Working with Alex

Spanos taught me to have a

“can-do” attitude. From a

man who overcame

adversity early in his life to

become one of America’s

true Horatio Alger success

stories, Alex advised me to

set achievable goals in life

and, when confronted by

challenge, to act with

integrity and dedication to

“just make it happen.”

G&D: Thank you very

much for your time, Mr.

Glass.

institutional investors

almost always sided with

incumbent management

against activist shareholders,

in recent years dissident

shareholders have actually

more often than not won

the majority of proxy

contests or reached

favorable settlements, such

as board representation, to

avert a proxy contest.

Although there is still the

classic management / agency

dilemma in corporate

America, the board and

management of more

companies, recognizing their

fiduciary duties to

shareholders, have become

appropriately more

responsive to activist

investors. We think activist

investing is still in its early

stages here, and

international markets are 10

to 20 years behind the U.S.

with regard to corporate

governance and activism.

G&D: In terms of the

range of activists, from

friendly activists such as

Relational at one end to the

more antagonist activists on

the other end of the

spectrum, where do you

stand? Why is this

approach best for you?

RG: We are in the middle

of the activism spectrum

with flexibility to work on a

constructive, collegial basis

with incumbent

management to the extent

they are legitimately willing

to explore ways to enhance

shareholder value, but also

to work as a staunch

defender of shareholder

rights in cases where


“In a study

conducted by

researchers at

Wharton and

Columbia Business

School, companies

which had been the

subject of 13D

filings indicating the

presence of an

activist shareholder

generally

outperformed the

S&P 500 by

approximately 5%-

7% per annum.”

Jon Friedland

the stock was widely owned

by many hedge funds. After

a few years at that fund, Pat

Duff, a fellow CBS Alum

who had been one of my

visiting Security Analysis

professors, introduced me

to Paul Orlin and Alex

Porter of Amici Capital.

We hit it off very well in

terms of investment

philosophy and approach.

That was over 10 years ago

and I still come to work

happy every day.

G&D: What is the meaning

behind the name of your

firm, Amici Capital?

JF: As of January we

changed the name of the

management company from

Porter Orlin to Amici

Capital to align it with the

name of our funds. ‘Amici’

in Latin means ‘friends’. The

capital that was initially

raised was from friends, so

from the beginning Amici

was used in our funds’

names. Since the firm’s

establishment in 1976, we

have maintained the

philosophy that our

investors and partners

should be treated as friends.

Amici is also reflective of

the cooperative culture

within the firm.

G&D: What drew your

initial interest to investing

primarily outside of the

U.S.? What are some of the advantages and

disadvantages with an

international focus?

JF: Halfway through my

college career at Vassar, I

took a semester off and

backpacked around Asia.

This was perhaps my first

explosive learning

experience. I traveled by

boat, bus, train, and plane all

over China, Tibet, Thailand,

Vietnam, and Nepal. For

someone that grew up in

Ohio, this was really an eye-

opening trip. I fell in love

with learning about different

cultures, which led me to a

five-year career in foreign

aid prior to attending CBS.

The great thing about the

investment business is that

there are investment

opportunities to suit

anyone’s background,

interest, and creativity.

When I came to Amici in

2001, there was little

international investment.

Then in 2002 we saw a

number of restructurings of

international companies in

industries that I had studied

carefully in the U.S. –

specifically the

telecommunications and

cable television industries.

Companies like NTL

Incorporated in the UK and

pan-emerging market cell

phone operator Millicom

International were trading at

distressed levels because of

forced sales and complexity.

The comfort that I had from

my foreign aid work in

Africa, Asia, and Latin

America was important. It

helped us to become more

comfortable applying the Amici investment process of

deep fundamental business,

industry, and valuation

analysis to recognize that

these companies were

trading at a significant


hedge fund, where he was

responsible for media,

entertainment, and leisure

ideas for the firm. Mr.

Friedland received his B.A.

in Political Science from

Vassar College in 1991 and

his MBA from Columbia

Business School in 1997.

G&D: How did you first

become interested in

investing and what brought

you to Amici?

JF: At Columbia Business

School, I took a number of

classes that had a profound

impact on the course of my

career. Bruce Greenwald’s

Value Investing class was

one. The creativity and

clarity with which he

analyzed businesses was

fascinating. Second was

Security Analysis with Jim

Rogers. He put students in

the role of a real time

company analyst. New

York-based investment managers with expertise on

our companies would come

to Jim’s class to grill us. It

was great. It gave me a

sense of how much you

should know before making

an investment. And I fell in

love with the explosive

learning process that

accompanies primary

research on an industry or

company.

I was hired out of CBS by a

large hedge fund because I

had done some original

primary research on an

ultrasound system

manufacturer for that

Security Analysis class. My

research suggested the

company’s stock was highly

overvalued, at a time when


“The great thing

about the

investment business

is that there are

investment

opportunities to

suit anyone’s

background,

interest, and

creativity.”

Jon Friedland


Jon Friedland

How do you narrow down

your hunting ground to a

manageable level from

which to sort through to

find new ideas?

JF: We try to invest in the

same way and in the same

types of companies no

matter where we invest.

We are looking for great

franchises trading at

substantial discounts to

intrinsic value.

We invest in emerging

markets because our view is

that consumers, corporates,

and sovereigns in emerging

markets have far better

balance sheets than they do

in the developed world. As

a result, we believe that

economic growth in

emerging markets is going

to be far greater than it will

be in the developed world.

The World Bank just

published a study projecting

that GDP growth in

developed countries in 2013

will be 1.2% and in

developing markets it will be

5.5%, which is a huge

differential.

Within that context we take

a multi-pronged approach.

First, we invest in

companies doing business in

specific emerging market

countries, India and Brazil

being primary examples,

where we have a high

degree of confidence in the long-term macro outlook.

Both countries have large

populations and diversified

economies that are capable

of supporting world-class

companies. Second, both of

those countries are fairly

inwardly driven. Imports to

GDP plus exports to GDP

sum to a mid-30% of GDP

in both, which is quite low

by comparative standards.

We like internally-driven

economies because they are

less subject to global

economic winds.

Increasingly we have also

developed contacts and

experience in these

countries, which has

increased our comfort level

further.

Secondly, we invest in global

companies that do business

in a portfolio of emerging

markets countries, many of

which we would not invest

in directly. We are able,

through a portfolio

approach, to take advantage

of positive trends in

countries in which we

would not take a

concentrated position.

Brazil and India have

predictable government

policies and a rule of law

that we understand. We

cannot say this about many

other countries.

G&D: How do you go

about looking for new ideas?

JF: As our team travels,

reads, and speaks to people,

we are always looking for

great companies that we

would love to own at the

right price.

We enter these companies

into a database and refer to

these companies as our

‘Battleships’. These are

large, highly profitable, and

well-capitalized companies


discount to intrinsic value.

Around this time we were

also short automotive

manufacturers in the U.S. in

large part because

competitors in Japan and

elsewhere were gaining

market share and operated

with structural advantages.

Additionally, we were short

some IT consulting

companies in the U.S. as

their most profitable

business lines were facing

stiff and increasing

competition from Indian IT

outsourcing companies.

I think at that time, and

increasingly since then, the

ability to apply our

investment process to an

expanded universe of

investment candidates

improves the likelihood of

our success. I think this is a

big advantage for us.

G&D: Are international /

domestic pair trades, such

as the aforementioned ones

from a decade ago, a big

part of what you look for?

JF: We do not seek out

pair trades. We are quite

active in our industry

analysis in trying to identify

both winners and losers.

Sometimes this will result in

a short or hedge from the

same industry, but each

investment, long or short in

our portfolio, goes through

the same investment

scrutiny and must stand on

its own.

G&D: There is an

extensive universe of

international companies.


Jon Friedland

opportunities presented to

them. We have met and

studied management at

most of these companies,

and have done extensive

work on them over the

years.

G&D: How do you find

the next name to add to this

list, the 101st company?

JF: It comes slowly. We

may add two to five

companies a year, while at

the same time a few

companies will come off of

the list if some missteps

have happened or the story

has changed. We do a lot

of traveling to Latin

America, Asia, and Europe

looking for new ideas and

we like to meet with new

companies. We are always

looking for new candidates.

G&D: How important is

meeting with a management

team face to face?

JF: It is very important.

We believe that strong

management teams play a

critical role in the ultimate

success of an investment.

We need to know that

management teams are

thinking like owners and we

have to understand their

long-term outlook for their

company and their industry.

We need to understand

what is important to them,

how they incentivize their

employees, and what their

company culture is like. For

us, this interaction is

important and can be telling.

I can recall one otherwise

promising investment that

we passed on after meeting

the CEO who was very

crude, which we feared was

an indication of poor judgment in other areas.

G&D: How do you manage

your long and short

exposure? Is there any

mathematical component to


that have demonstrated

pricing power in

consolidated industries with

low competitive intensity.

They are run by

management teams that

have established a record of

intelligent capital allocation

and have made strategic

decisions we understand.

We believe that investing in

‘Battleship’ companies, as

distinct from very small

upstart companies with

illiquid stock, gives us an

added margin of safety

because these companies

are less likely to be blown

around by economic

volatility. We believe this is

an important risk

management component

when investing in emerging

markets, where both

operating performance and

stock price performance can

be more volatile.

G&D: It sounds like you are looking for ‘Warren

Buffett-like’ companies and

have a longer-term time

horizon than the typical

hedge fund.

JF: In a way that is right.

Our Battleships list contains

roughly 100 international

companies that we would

like to own at the right

price. We may own only a

certain number of these

companies at any given time,

but pick our entry and exit

points based on current

valuations. They may not all

be attractive investments in

any particular year, but the

common thread is our high

degree of confidence in

their long-term ability to

capitalize on the


“We believe that

investing in

‘Battleship’

companies, as distinct

from very small

upstart companies

with illiquid stock,

gives us an added

margin of safety

because these

companies are less

likely to be blown

around by economic

volatility. We believe

this is an important

risk management

component when

investing in emerging

markets, where both

operating

performance and

stock price

performance can be

more volatile.”

Pictured: Jon Friedland

speaking at the Moon Lee

Prize Competition in Janu-

ary 2012.


Jon Friedland

that the much faster growth

rates of the developing

world economies described

in the World Bank report

we discussed, coupled with

a valuation discount to

developed market stocks,

creates a rich opportunity

set in emerging countries.

Now is an interesting time

to invest in emerging

markets because emerging

market governments are

increasingly making positive

long-term policy decisions,

having exhausted most

other options. This is in

part because many

countries are bumping up

against more governors on

their growth rates than they

have in the past decade.

Inflation recently has been

stubbornly high and a lot of

labor has already come into

the labor pool. More

fundamental changes and

action from governments is

required than has been

necessary over the past

decade. What gives us

comfort is that we are

starting to see that happen.

For example, in India since

September we have seen

liberalization relating to

foreign direct investment in

retail and aerospace, a

reduction in subsidies for

diesel and natural gas prices,

and the first hike in

government-run railroad

fares in a decade. Real interest rates in Brazil have

plummeted from over 10%

to less than 2% in the past

eight years, much of this

reduction in the last year

and a half. The government

in Brazil has recently issued

RFPs for $65 billion worth

of infrastructure products.

A lot of emerging markets

are turning the global

liquidity surge from

developed market central

banks into their advantage,

trying to steer capital

toward foreign direct

investments as opposed to

portfolio flows. We look at

this as a third, and smarter,

stimulus tool in addition to

the more conventional fiscal

and monetary tools.


an idea that you like right

now?

JF: Our compliance

department will not allow

me to mention specific

names, but I can speak more

broadly. Real estate in India

is currently an area that is

ripe for investment. There

are a few ‘Battleship’

companies that have

managed to come through

the latest down-cycle intact

and are in a good position.

We have a position in a

company that owns a land

parcel outside of a major

Indian city, in an area akin to

Greenwich, Connecticut

outside of New York, which

it is developing into

residential and commercial

space. We believe it has an

asset value substantially

greater than its current

market value. The question is whether this asset value

will ever be realized for the

benefit of minority

investors.

We are seeing signs of


it, or is it more based on

the quality of long and short

ideas at a point in time?

JF: The Amici Global Fund

that I manage is somewhat

different than our core

funds. It offers

concentrated exposure to

the international positions

within our core Amici funds

managed by Paul Orlin. The

Amici Global Fund was

established to take

advantage of the attractive

emerging market dynamics

we discussed before. It

generally has a larger net

long exposure and accepts

more volatility on the

assumption of a highly

attractive long-term

opportunity. At any given

time, our exposure is a

function of the risk/reward

opportunities we are seeing

with individual stocks. We

are not macro investors.

We also pay close attention

to valuations across the

emerging market asset class

on an absolute basis and on

a relative basis compared to

developed markets. This

analysis goes back 20 years

to give us a sense of

whether the odds are

stacked in our favor.

Emerging market stocks are

volatile and correlated, so

we think it is important to

be conscious of this data.

G&D: Where are we

today in terms of emerging

market attractiveness versus

developed markets?

JF: Sometimes you have to

go outside the U.S. to find a

‘grand bargain’. We believe


“Sometimes you

have to go outside

the U.S. to find a

‘grand bargain’. We

believe that the

much faster growth

rates of the

developing world

economies

described in the

World Bank report

we discussed [1.2%

growth in

developed countries

vs. 5.5% growth in

emerging markets],

coupled with a

valuation discount

to developed

market stocks,

creates a rich

opportunity set in

emerging

countries.”

Jon Friedland

Brazil. But to support

growth, Brazilian

homebuilders began to

outsource oversight of

construction to such an

extent that they lost

complete control of the

process. The cost and time

overruns were enormous

and destroyed profitability.

Because of the way things

are accounted for, the

entire hit to profitability

comes at the end of a

project – you can’t go back

and restate prior periods.

Financial results look

terrible now but new

construction launches have

declined substantially from a

few years ago. We think

that profitability of these

companies may very well

return to high levels. These

companies are currently

trading at or below

liquidation value, with no

value ascribed to the

ongoing value of the

business.

G&D: We remember the

impact that the Beijing

Olympics in 2008 had on

the level of investment

spending in China. How

much do the impending

2014 World Cup and 2016

Olympics impact the way

you look at construction in

Brazil?

JF: I look at these events as

helping force good

decisions. Airports, rail lines, and roads around the

country are going to have to

see some investment. Brazil

has among the worst

infrastructure in the world.

I am hopeful that these

events are serving as

catalysts to help get the

Brazilian government to

take some positive actions

as discussed earlier.

G&D: It seems that you

are primarily focused on

hard asset plays in emerging

markets. Do you spend

much time looking at other

types of businesses in these

markets?

JF: Absolutely. There are

such powerful tailwinds

behind consumers, such as

rapidly rising wages and

standards of living.

Consumer-focused

companies are among our

favorite investment themes

in developing markets, as

long as we can purchase

them at reasonable

valuations. We have

invested in drugstore and

mall companies in Brazil.

There is a big secular shift

from informal to formalized

retail in the country. Some

of these companies that

have scale, buying power,

and systems are benefitting

tremendously. In India we

have invested in beverage

companies. Last year we

invested in a company that

had substantial share in the

beverage industry. It ran

into some distribution

issues that had impaired

profitability in the short

term. We studied how

similar disruptions had

impacted profitability at the company over medium-term

periods, and realized that

the company was likely to

recover and pass through

incremental costs that it

faced. In fact, it was one of


positive strategic changes in

operating practices that

suggest the asset value may

become visible and we are

hopeful that it will

appreciate in the next year.

We have seen developers

sell down crown-jewel

assets and non-core assets

to shore up their balance

sheets. We see a

willingness to re-focus

business models on core

competencies. The roots of

these management teams

are as buyers, developers,

and marketers of land.

They have now outsourced

construction and project

management to best-in-class

companies and substantially

reduced the volume of

product they seek to bring

to market annually. This

will improve quality, pricing

integrity, and ultimately cash

flows.

Furthermore, in India we think there is a good chance

that interest rates come

down in the next year,

which will increase

valuations and will increase

the availability of mortgages

from extremely low levels.

Mortgages are below 5% of

GDP in India, well below

the global average.

We see a similar situation

with Brazilian homebuilders.

Over the last residential real

estate cycle, all of the

developers raised money at

the same time and began to

grow launches at multiples

of prior 5- and 10-year

rates. Unlike in India,

project oversight and

management was a core

competence historically in


Pictured: Paul Orlin of

Amici Capital speaking at the

Moon Lee Prize Competi-

tion in January 2012.


Jon Friedland

Your Core funds were

down less than 6% versus a

37% decline for the S&P

500. How were you able to

achieve such a great year

when many other hedge

funds and the broader

market struggled?

JF: We have a culture of

risk management at Amici

Capital. It is always primary

in our minds. We are never

going to chase performance

if we don’t think the

opportunity set looks

attractive. We are heavily

short single names – this is a

core part of what we do. In

the process of turning up

great businesses you are

always going to turn up

some losers. It is important

to hedge the portfolio with

a set of companies that are

misunderstood from a

perspective that is too

optimistic. Our

performance in 2008 was a

function of sensing the risks

in the global

macroeconomic

environment and reducing

exposure slightly, and, most

importantly, having a set of

shorts that were oriented

toward the leverage that

had built up in the system.


parting words of wisdom

for our readers?

JF: As you come out of

business school it is important to take the best

opportunity you can find

where you can get the best

exposure to a variety of

situations so you can see

what you like and what you

are good at. Ideally that job

ultimately becomes a long-

term proposition, but once

you are seasoned and have

some maturity allowing you

to understand yourself

better, you might discover

that you should be

elsewhere instead. Find a

place that you are

comfortable with. I was at a

growth-oriented hedge fund

prior to coming to Amici

and found myself as the ‘low

-beta’ guy there, whereas at

Amici Capital I tend to be

more comfortable as the

‘high-beta’ guy. Find a place

where you can bring your

interests, your passions, and

your experience and try to

differentiate yourself.

G&D: Thank you for

sharing your thoughts with

us, Mr. Friedland.

the largest contributors to

last year’s profitability.

G&D: What is Amici’s

“secret sauce?” What has

led to you outperformance

over the long term?

JF: We have an investment

process that has been

refined since 1976 and we

seek constant improvement

in that process. We know

how to identify great

businesses and broken

businesses. We have the

ability to judge management

teams by meeting with them

and by analyzing quantitative

changes that occur in a

business while a specific

team is in charge. We also

constantly assess risk/

reward in our individual

positions and pockets of

risk in the portfolio.

Over the past eight years,

we have developed a wide array of contacts across the

globe. There are not many

funds that are U.S.-based

value investors that have the

ability or the inclination to

look intensively for single

names in many foreign

countries. We’ve found

ourselves increasingly

capable of monitoring many

different situations via our

list of ‘Battleship’

companies. When a

disruption takes place with a

company on this list, due to

our team-oriented nature,

we are capable of collapsing

a lot of resources on an idea

and quickly coming to a

conclusion.

G&D: Amici had great firm

-wide performance in 2008.


“We have an

investment process

that has been refined

since 1976 and we

seek constant

improvement in that

process. We know

how to identify great

businesses and broken

businesses. We have

the ability to judge

management teams

by meeting with them

and by analyzing

quantitative changes

that occur in a

business while a

specific team is in

charge. We also

constantly assess risk/

reward in our

individual positions

and pockets of risk in

the portfolio.”

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Graham & Doddsville 2012 / 2013 Editors

Jay Hedstrom is a second-year MBA student and a member of the Heilbrunn Center’s

Value Investing Program. During the summer Jay worked for T. Rowe Price as a Fixed

Income Analyst. Prior to Columbia Business School, Jay worked in investment grade

fixed income research for Fidelity Investments. He can be reached at jhed-

[email protected].

Jake Lubel is a second-year MBA student and a member of the Heilbrunn Center’s

Value Investing Program. During the summer he interned at GMT Capital, a long-short

value fund. Prior to Columbia Business school he worked under Preston Athey on the

small-cap value team at T. Rowe Price. He received a BA in Economics from Guilford

College. He can be reached at [email protected].

Sachee Trivedi is a second-year MBA student. Over the summer this year, she in-

terned at Evercore Partners in their Institutional Equities division as a sell-side research

analyst. Prior to Columbia Business School, Sachee worked as a consultant in KPMG’s

Risk Advisory business and at Royal Bank of Scotland in London. She can be reached at

[email protected].

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